Key issues, risks and opportunities for small business that a practitioner should be aware of as they approach year-end

Last updated 6 April 2022

Deborah Jenkins, Deputy Commissioner
Chartered Accountants Australia and New Zealand Strategic Tax Planning Conference, 6 April 2022.
(Check against delivery)

Introduction

In the spirit of reconciliation, I would like to respectfully acknowledge the traditional owners and custodians of the land on which we all meet across the country. I would also like to pay respect to the elders past, present and emerging. I would specifically like to acknowledge the Gadigal of the Eora nation, the traditional owners of the land I am presenting from today.

I often say being the Deputy Commissioner, Small Business at the ATO is like being asked to make baby bear’s porridge – not too hot, not too cold – just right.

What do I mean by that? Well, it is not uncommon for us to be accused of being too soft on small business and not hard enough on small business in the same breath (especially when those small businesses are small employers who are not paying their employees' superannuation). My job (working with others across the ATO) is to strike the right balance and to help small businesses meet their tax, and superannuation, and registry obligations both in my role as Deputy Commissioner Small Business Line and as the Small Business Experience owner.

Today I’d like to share with you the work my team and I do at the ATO to understand both what is happening out there in the community and also why small businesses are behaving in a particular way. This work is so important so we can get the settings ‘just right’.

We like to do this using as much empirical evidence and facts as possible and not just ‘annec-data’. We are often told things like ‘lots of members have asked about’ but when we ask for more details to understand – we discover that the issue is limited to a smaller population than initially thought. What I have begun to appreciate in the six years I have been at the ATO is that, as an adviser, I didn’t have an appreciation of the full range of behaviours within the markets and that many of the technical issues I perceived to be broad reaching or significant, just weren’t, (in the scheme of things).

Speaking of understanding the behaviours within the market and what drives small businesses to behave in particular ways, I acknowledge over the last couple of years many small businesses and their advisers have been impacted by COVID-19.

Challenging economic and personal conditions have resulted in things such as a reduction in customers or sales, changes to the way you or your clients operate, or having to pause or close your or your client’s business due to restrictions, lockdowns, isolating or lack of consumer confidence. This followed closely on the heels of devastating bushfires, droughts, and before that, floods. And of course, more recently (and for some areas unfortunately currently) the east coast floods.

As I did last year, and I would like to do so again, I want to start by saying thank you for everything you did to support the Australian community in a time of need (and many of you helped us support the Australian community too). When I spoke with you last year, I think we saw some light at the end of the tunnel – we didn’t expect to have to find the reserves for another 12 months of continued uncertainty and challenge.

I know it hasn’t been easy for you. This support has come at personal cost for many of you, and you are tired – we understand this, which is why it is so important to reinforce that we are on the same team. We want to continue this effective partnership as we work with small businesses to help them recover, maintain, or exit gracefully (or with dignity).

I don’t say this for sympathy but, like all Australian operations, COVID-19 has had an impact on our capacity at times. In one of my teams the other day I had 50% of the staff away with COVID – not just isolating. We are trying to be as agile as possible but right now it may take us just that little bit longer to do some things.

What we know about the small business market

Let’s begin (as I always do) with an overview of our small business population – this is important because it helps set out the challenge we have as a regulator to work at scale in such a diverse market.

As you may recall, for ATO purposes, we define a small business as sole trader, company, trust, or partnership which has an annual turnover of less than $10 million (this has not moved to $50 million for ATO client experience purposes). But as you can imagine entities do move each year between the Privately Owned and Wealthy Groups segment (which Deputy Commissioner Louise Clarke has responsibility for) and the Individuals market (which Deputy Commissioner Hoa Wood looks after) - depending on their turnover in any given year and whether they continue to be in business.

So here are some of the key statistics:

There were approximately 4.3 million small businesses as at 30 June 2021.
83% of small businesses have no employees. Around 720,000 are employers, employing over 6 million employees, which is the equivalent to about half the Australian workforce.
Small business accounts for around 20% of the ATO’s total income tax collection and around 30% of GST collections.
The largest type of small business entities are sole traders (44%), followed by companies (27%), trusts (21%), and partnerships (8%).
In addition to the small businesses themselves, there are 2.1 million linked individuals including directors, shareholders, partners, and trust beneficiaries totalling over 6.4 million small business entities in Australia.
Around 2.4 million small business entities are GST-registered
Approximately 70% of small businesses have annual business income below $75,000 (including 25% with $0 or less). And 4% have turnover between $1 million to $10 million.
88% of small businesses have their income tax returns lodged by a tax practitioner, while around 65% have their activity statements lodged by a practitioner.

In addition to this underlying diversity, we really do have a multi-speed economy at play. For some businesses COVID-19 has had absolutely no impact, for other businesses they have never done better, some businesses are recovering well, and others continue to struggle or have just simply given up. We see that in our engagement with small businesses and their advisers across the country.

As a regulator, trying to understand the situation of 4.3 million entities, not only are the population attributes varied, but also each business has been impacted so differently by the events of the past two years. It is not something that industry, postcode or even street can give you a definitive answer on. It is why I make no apology for taking the approach we have, which is asking business and their advisers to engage with us directly to tell us their story whether that is about lodgment deferrals, payment plans or during an audit (asking for a pause), so that we can tailor an appropriate response.

Tax gap or tax performance and how the results are driving our strategies

To set the scene for our focus areas in 2021-22 I will again share what fundamentally underpins and informs our strategies in the small business market, which is our tax gap program. Our tax gaps are published annually in our Annual Report.

For 2018-19 the small business client experience net tax gap is estimated to be 14.8% or $14 billion. This means that 85.2% of the theoretical tax liability in the small business client experience was paid voluntarily and after our compliance activity. When you think about it, that is a pretty incredible number. This market estimation of the tax gap draws on three key published tax gaps - the small business income tax gap, the GST gap and the fringe benefits tax gap.

What we have continually said about the small business random enquiry program used to calculate the income tax gap for this market and, it is true again this year, is:

Most small businesses comply with their obligations. Those that keep good records, use fit for purpose digital business solutions and seek timely advice from a tax professional are more likely to be reporting correctly.
Small businesses struggle with complexity (perceived or actual) and have more challenges than other client experience segments.
A small percentage of small business taxpayers engage in shadow economy behaviour including deliberately under-reporting income, over-claiming expenses or operating entirely outside the tax system. However, this group has the biggest impact on the tax gap (around $6 billion income tax, around $1 billion GST). But more on that later.

The small business income tax gap estimate and the associated random enquiry program (where we review the income tax affairs of randomly selected small businesses) again continues to play a central role in helping us understand compliance challenges faced by small business (and what good looks like).

Most small businesses are doing the right thing or are trying to. By measuring the income tax performance of small business taxpayers in Australia, we see that this population voluntarily contributes over $85 billion in income tax – this is around 87% of the revenue we expect from them.

The estimated net income tax gap for small business for 2018-19 is 12.7% (or $12.5 billion). The main components of the small business income tax gap are:

omitted income
over-claimed deductions
people outside the tax system, for example, cash-only businesses operating without an Australian business number (ABN)
non-pursuable debt, that is not economical for us to pursue.

Most of the small business taxpayers reviewed in the sample were found to have reported correctly or were considered to have genuinely attempted to do so. Of the businesses in the random enquiry program, we saw around 64% doing their best to report correctly and pay the right amount of tax.

Where incorrect reporting was identified, the most common issues we saw included:

undeclared income
business owners failing to account for private use of business assets or funds
inadequate record keeping systems or business owners not keeping the required records.

Around 5% of taxpayers in our sample made mistakes as a result of complexity – this group were responsible for around 7% of the missing revenue we identified. Errors for this group involved mistakes relating to reporting obligations for the business structure, or of law surrounding specific tax issues such as fringe benefits, personal services income, capital gains tax, Division 7A, foreign income and Legal expenses, and associated travel costs.

Overall, we observed a wide range of behaviours relating to adjustments, including:

misunderstanding or misapplication of tax law
carelessness
poor record keeping and lack of reconciliation processes
business owners appearing to deliberately avoid paying the right tax (for example, making minimal effort to comply with their obligations)
deliberate attempts to avoid paying the right tax (this behaviour is known as shadow economy or black economy behaviour).

The tax effect of the shadow economy for small business in 2018–19 is estimated to be $6.3 billion (or around 47% of the gross income tax gap). Most of this activity ($4.3 billion) is associated with deliberate under-reporting of business income and over-claiming of business deductions.

While shadow economy behaviour is still contributing significantly to the tax gap, only 3.5% of the small business taxpayers reviewed as part of the random enquiry program sample clearly made deliberate attempts to avoid paying the right tax - reinforcing that it is a small proportion of the small business client doing the wrong thing but it adds up to a larger number which the community is missing out on.

Tax practitioner behaviours observed

We appreciate that tax practitioners play a role in shaping the reporting behaviours of small business. In the random enquiry program, we continued to see many examples of tax practitioners helping small businesses to report correctly. However, for completeness we also identified:

some mistakes as a result of tax practitioners failing to show reasonable care including tax practitioner failing to question the income and expense discrepancies between the general ledger, income tax return and profit and loss statement.
a small number of tax practitioners aiding a taxpayer's deliberate attempt to avoid paying the right tax.

Using all information sources to design our approaches - what we get asked

As I said, we like to base our compliance approaches on data and facts, in addition to the valuable information we get through the random enquiry program. Another source that informs our work to close the small business tax gap and improve tax performance can be found in the questions we get asked by the community.

So, in that spirit, I’d like to share with you the flavour of the questions relevant to small business that we were asked during the year. There are a variety of sources of questions that come into the ATO from small businesses and their advisers right across our organisation, but I selected the following sources as illustrative:

Call centre contacts
Small Business Technical Leadership and Advice requests
ATO Community (online)
GST Technical Leadership and Advice requests.

Broadly, from a small business perspective our top five queries to our contact centres are about:

Payment plans / negotiations about debt
Single Touch Payroll
Relationship Authorisation Manager – relevant to MyGovID
Director ID requirements
Activity statements – a wide variety of questions about this.

I’d also note that around 20% of our calls related to information on operating a business. This includes clarity around digital services (such as RAM) and starting up a business. Which leads me nicely to the most common advice and ruling requests Assistant Commissioner Anthony Marvello, who heads up our Small Business Technical Leadership and Advice area, gets asked about:

Small business CGT concession requests – basic conditions, active asset and 15-year exemption are the most common concession questions. We are reviewing targeted tax time communications to ensure our public guidance is useful in this regard.
Am I in Business – share trading, rental properties, and cryptocurrency are the most asked activities for private rulings on ‘Am I in Business’. To address this, we are looking at an ‘Am I in business/what to do if I am business’ guidance push for later this year.
Non-commercial losses – Commissioner’s discretion requests - special circumstances is the most common basis for a discretion request. COVID-19 was provided as the most common reason for special circumstances. We are drafting a Practical Compliance Guideline which will set out the Commissioner's preliminary view on how the discretion in the law may provide a safe harbour for individuals that make a loss from non-commercial business activities due to flood, bushfire or COVID-19.
Deductions – Specifically temporary full expensing, depreciation and legal expenses are the most common requests. We are monitoring for any increases and fine-tuning our web content when necessary.
Personal Service Income/Personal Services Business Determinations – ‘unrelated clients’ and ‘results’ are the most common test questions. We are refreshing the web content and PSI tool and planning to finalise a new Tax Ruling on Personal services income this year.

Anthony is keen to continue to work with Susan, Michael and Karen (CAANZ) from an advice and guidance perspective about how the ATO and CAANZ can best work together to assist and provide advice for matters of broad application that taxpayers and their practitioners can use without the need, time and cost of seeking advice on a client-by-client basis.

Many of you will be familiar with our ATO CommunityExternal Link, which is an online community where everyone can share current issues and crowdsource answers. The top five small business topics on ATO Community right now are:

myGovID Issues – businesses want to know how to verify their identity, how to log into myGovID and how to solve error codes that they receive. myGovID questions alone have received over 6,000 views in the last month and is currently the most popular topic of discussion for the small business audience.
Instant asset write-off queries – businesses have been viewing conversations regarding eligibility for the instant asset write off scheme and the interaction with temporary full expensing - we’re still seeing large amounts of traffic to these conversations.
Is my side hustle a small business? – We’ve had a big influx of discussions around extra sources of income and how they relate to tax as a business. The main interest has been around declaring income from digital content creation. These questions have accumulated over 1,300 views in the last month and represent an emerging topic for tax time.
GST obligations – businesses have been clarifying how and when to claim GST credits, and asking questions about GST applicable sales.
Business registrations – businesses are frequently asking about ABNs, specifically, when to register for one and how to update / cancel one. In the past month, we’ve had over 40 conversations relating to ABNs.

We encourage anyone interested in ATO CommunityExternal Link to join or start a discussion.

And finally, some of the key issues from a GST perspective relevant to small business have been:

Time limits on GST credits – we have an awareness campaign to make sure businesses are aware that GST credits expire if not claimed within four years.
We are reviewing our web guidance to determine how we can make things as easy as possible for clients to determine the GST treatment of their property transactions, particularly in relation to subdivisions of land.
We have developed web content addressing the GST implications of monetarisation of a social media presence cross border which is scheduled to go live on our website this month.
Due to world events and COVID-19, we are seeing increasing numbers of requests to extend the GST-free export period beyond the legislated 60 days. Extensions are being granted for circumstances beyond the control of the exporter.
We are seeing an increased interest from smaller importers in the deferred GST scheme which assists a business’s cashflow but does require businesses to be a monthly lodger.
And of course, the end of year is a great opportunity for a governance check to make sure food and health products sold are correctly classified for GST purposes. We are updating our website for new products and also products of concern that are identified through compliance reviews. If you or your clients have incorrectly classified products or you are unsure, it’s important to contact us.

I have observed that stimulus measures (such as Cash Flow Boost and JobKeeper) and other new measures such as Single Touch Payroll or Director ID have brought to the fore issues that have always been there but not focussed on to the same degree either by the ATO, or taxpayers and advisers. For example:

Are you an employee or a contractor
Documenting agreements or transactions between parties particularly when they are friends or family; closely helds and the frequency or otherwise of payments between parties
Lack of understanding about obligations of running a company and being a director (for example, do I need a Director ID?)
Whether someone is actually in business
GST registrations – what does it mean to be registered and am I eligible
That completing business activity statements correctly, actually matters.

What I would say is that, unfortunately we often get to see these things when it goes wrong. We know that small businesses enter into arrangements when it is ‘happy families’, with no thought about wages, superannuation or employment contracts.

They seem to go along happily until there is a breakdown in relationships and then we get a call to our Tax Integrity Centre or an employee notification in relation to unpaid superannuation guarantee. We see sad situations of brother against brother, sons against parents, siblings against siblings, sister against aunty. In many cases we have no choice but to apply the law based on the situation as we find it. Often, this is not the outcome anyone had in mind.

My message is to keep good records and to document the intended relationships upfront so there is no disagreement later if the relationship sours.

Our risk focuses – also referred to as our compliance strategy

Each year at the CAANZ Tax Strategy Session I outline our areas of focus for the year ahead – it is our equivalent of the release of the Compliance Program. This year is no different (although a little earlier). We are currently planning our program for 2022–23 but I can share with you the areas that we will be focussing on.

As we always say, getting tax and superannuation understood by small businesses and their advisers, and the right amount paid in the first place, is the most efficient way to administer the tax system. Our aim continues to be to sustainably and sensibly improve small business tax performance through tailored strategies based on client behaviour and delivering improved digital and data experiences. We know that we can’t audit our way to success.

There are four areas our strategies will focus on this year and in coming years:

shadow economy
mistakes or complexity (real or perceived)
the growing small business debt book
refund fraud (primarily GST).

Shadow economy

As I said, 87% of income tax in the small business market comes in voluntarily but there is an $11 billion income tax gap of which $6 billion (or just slightly over half) is as a result of shadow economy behaviour.

We have a one-year extension of the funding for the Shadow Economy Program. We will continue with many of the strategies including level playing field and leveraging tax practitioners, the Tax Integrity Centre, utilising the standing Taskforce and many other things.

We will continue our focus on the taxable payments reporting system (TPRS) and the taxable payments annual report (TPAR) – how do we get the forms completed and then how to we leverage that information through nudges and pre-filling (as appropriate).

As part of our omitted income strategies, we continue to investigate the illegal use of electronic sales suppression tools (ESST) by a small percentage who are deliberately under-reporting their income.

An ESST can be a device, software program or other thing that can interfere with a business’ sales records electronically. This allows sales and income to be under-reported, and in turn, less tax to be paid. This contributes to the shadow economy and is unfair to honest businesses that do the right thing.

Mistakes or complexity

Using the intelligence and information described above we will address these issues with a range of strategies to address the particular challenges identified. How we can help taxpayers and their advisers understand what they need to know and when they need to know it.

By way of an example, many in the small business community don’t know they are directors or may not see themselves as directors. This year we will continue to remind small businesses of their obligations to have a Director ID if they are a director. It is estimated there are approximately 2.9 million directors of companies, registered Australian bodies, or registered foreign companies in Australia, and around 65% of this number come from small businesses.

Addressing the growing small business debt book

Small business continues to account for around two thirds of the total debt owed to the ATO. We know that the longer a small business doesn’t engage with us about their debt, the more likely it is to grow and the harder it is for a small business to get back on track.

We strongly encourage small businesses to engage with us, to consider setting up a payment plan. Our message today is the same that it has always been – it is never too late to engage with us.

There are a range of strategies being used to address this from Digital Cash Flow Coaching Kit, to director penalty notices and disclosure of business tax debts.

Refund fraud (primarily GST)

We know in challenging economic times, refund fraud is likely to increase. We continue to focus our efforts on improving our GST refund integrity. Where possible we want to move as much of the work to what we call ‘pre-issue’ before the refund issues, and to understand and address the behaviours that are causing refund fraud. We have redesigned strategies using improved data and contemporary risk models to allow us to do this more accurately (and faster).

Wrap-up

There is so much more I could talk about, but today I have provided you with some insights into the complex and evolving world of being a small business regulator. It is really unlike any other market. The vastness and complexity of the participants and the need to focus at scale, drives how we operate. As you can see, making baby bear’s porridge isn’t easy.

We continue to progress a range of projects to improve our digital services and use of data to both increase our ability to detect shadow economy behaviour, but more importantly, to make things easier and help everyone avoid small mistakes.

Thanks again for your support in the past 12 months – I personally really appreciate it.

I will hand over to Deputy Commissioner Louise Clarke now to take you through our focuses with private groups.

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