Do the tax crime, do the time

Tax fraud and tax evasion – we hear those terms regularly these days. It might be thought they refer only to the extreme end of the spectrum and to highly contrived and complex arrangements. Well, yes and no.

At one end of the scale, the Tax Office continues to fight tax crime that extends across international boundaries. While it says that much of the money involved in this is related to legitimate business and trade, or travel and tourism activities, some of it is not legitimate, with sophisticated business models set up – often through organised criminal networks – to avoid the Australian tax system. A recent investigation found Australian taxpayers used Vanuatu-based schemes to avoid paying tax. The offenders used false invoicing between a Vanuatu entity and an Australian entity that resulted in over-claiming of tax deductions.

Two high-profile tax crackdowns by the Tax Office have, in the last financial year, raised more than $313 million in tax liabilities and penalties, according to the Government. During the year ended 30 June 2009:

• Project Wickenby raised $230 million in tax liabilities and collected $40 million in cash. In addition, Wickenby collected $159 million in tax collected in subsequent years from taxpayers who have been subject to Wickenby action.
• Targetting of phoenix practices also raised more than $83 million in tax and penalties. According to the ATO, this activity is concentrated in business groups with turnovers up to $15 million and in sectors where labour costs are high relative to assets used, such as building and construction, security services and labour hire. The Tax Office said cases are managed by a dedicated phoenix risk management team with around 36 staff, which carries out phoenix-specific reviews and audits. Increased resources for this work were provided in the 2009 Federal Budget. The Tax Office says that some $694 million in taxes and penalties have been raised through 1,420 phoenix audits since 1998, when the ATO began a specific focus on phoenix arrangements.

The Serious Non-compliance unit of the ATO are the people who investigate serious tax fraud or tax evasion. Sounds fairly threatening right off the bat! And the penalties are serious too – conspiring to obtain a financial advantage by deception and money laundering carries maximum penalties of 10 and 20 years imprisonment respectively. The unit has runs on the board, and it is not always highly complex and sophisticated arrangements that bring people undone.

An example was where a restaurant paid cash wages not recorded on its books and also did not record all cash sales on the books. This might hardly seem remarkable in itself but the amount defrauded amounted to more than $300,000. A criminal prosecution ensued and the bookkeeper (who was married to a partner in the business) was ultimately sentenced to three years’ jail (minimum of 12 months).

While the business takings were a mix of cash sales and credit card transactions, the ATO said information it received indicated the business was paying cash wages that were not recorded in the pay books for staff, as well as cash purchases being made from the till. In addition, there were allegations of a second set of records for the business. The ATO’s initial compliance checks identified that not all cash sales were recorded in the books.

The ATO said it was suspicious that fraud offences might have been committed, so it sought the assistance of the Australian Federal Police to execute search warrants to obtain evidence of the potential offences. This identified a second set of records prepared by another person (other than the bookkeeper) for a four-week period in one financial year. These records indicated sales in excess of those recorded in the books of account that the bookkeeper provided to the tax agent to prepare the income tax returns.

An ATO audit showed that for the period covered by the second set of records, the percentage of cash sales was significantly higher than for the balance of the financial year. The bookkeeper maintained that the cash not banked was used to meet expenses that had not been claimed as deductions. When the ATO reviewed the business records, it found there were cash expenses, but it said they were much less than the additional income that was not recorded on the books of account provided to the tax agent.

The ATO subsequently issued amended assessments based on estimating the percentage of cash sales compared with credit card transactions from the second set of records for the full financial year. It also made allowance for additional cash expenses based on the gross profit margin that applied to the second set of records. The ATO then reviewed prior year tax returns which showed that the percentage of cash sales was lower than the percentage in the second set of records. Amendments were also made for the previous years for which records were available.

In the ATO’s view, the taxpayer’s behaviour was an intentional disregard of the tax
laws and a base penalty amount of 75% of the tax shortfall was imposed (as well as a general interest charge for the relevant period).

The result was that charges were laid under the Crimes Act alleging that the bookkeeper had defrauded the Commonwealth of more than $300,000, and a criminal prosecution commenced. The bookkeeper was found guilty of fraud offences and was sentenced to three years’ jail, with a minimum of 12 months to be served.

Tax fraud is a serious crime and it doesn’t always result from high-end sophisticated arrangements. It can result from lodging an activity statement claiming a false refund to, as in the above example, paying cash wages not recorded in the books or keeping more than one set of books. Tax crime can result in criminal prosecution and jail sentences. Be warned!

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.