ATO audit risks for SMEs that mix private and business expenses

The ATO plans to conduct some 250 SME audits for the 2012-13 income year. In fact, those audits, being conducted by seven ATO audit teams, have already started.

The ATO expects each audit to run for about 90 days and the current focus areas include repairs and maintenance (an oldie but a goody!), bad debts, other expenses, and poor economic performance (presumably through the use of benchmarks).

Recent audits have resulted in voluntary disclosures from taxpayers and have included issues with incorrectly claiming private expenses as repairs and maintenance. The audits also provide a valuable insight into how the ATO selects SMEs for audit and the processes that are involved.

So how are SMEs chosen for an audit? SMEs are chosen for audits partly based on their risk profiles, and the audits seek to obtain source documents to verify claims. The ATO also considers a three-year period to “smooth out the numbers” and it also compares entities with their peers, not just their industry, as part of risk profiling.

The ATO audit process involves several steps:

• Phone contact to arrange an interview. Following the initial phone call, ATO auditors are generally onsite within two weeks.
• Written confirmation of the audit.
• Provide an opportunity for the SME to make a voluntary disclosure. The ATO has indicated that many taxpayers and their advisers review their records prior to an audit and this often results in voluntary disclosures. Voluntary disclosures can result in reduced penalties, so should not be lightly dismissed by taxpayers.
• Walk through of the business.
• Two face-to-face visits, with each visit generally lasting around five hours on site.

In one audit conducted by the ATO, the taxpayer made a voluntary disclosure at commencement of the interview. The taxpayer had incorrectly claimed $500,000 as repairs and maintenance. They were prompted to review their records, and they identified a deficiency in their internal processes. The voluntary disclosure led to an 80% remission in penalties.

In another audit, private expenses were incorrectly claimed as repairs and maintenance. A renovation was done on a director’s private residence, and the ATO auditor identified the discrepancy from an examination of delivery dockets.

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