The taxman’s secret tool

Data-matching is set to catch out those in the cash economy. TERRY HAYES explains how it will work.

By Terry Hayes

Data-matching is set to catch out those in the cash economy. TERRY HAYES explains how it will work.

It is well known that the cash economy can cause trouble for small businesses. Through unrecorded and unreported cash transactions, it introduces unfair practices that can give one business an unfair advantage over another. Loss of business, and profits, can result for businesses adversely affected.

The Tax Commissioner recently described the cash economy as “a rogue cog in the wheel – a cog that gums up the works”.

In order to try to attack this “rogue cog”, and in line with the tax office’s view that “prevention is better than cure”, the Commissioner says the tax office is developing “benchmarks” or “industry norms” of likely business costs and income.

He says that over the last 12 months, the tax office has collaborated with a number of trade associations, tradespeople, taxi operators and tax practitioners to develop these business norm benchmarks.

Benchmarking gives businesses an idea of what range of income can be expected, based on the work they do and other costs they have. Business operators will be able to use the benchmarks to compare their performance with the rest of the industry and to check that their tax records accurately reflect their business practices.

Following this work, the tax office has now released three new industry benchmarks covering the:

• Floor sanding and polishing industry.
• Roofing industry.
• Painting industry.

It is also working on benchmarks for other industries.

The benchmarks provide guidance on the time and materials involved in an average job; for example, the amount of paint and roof tiles used in building jobs. These “inputs” are based on what a tradesperson uses when preparing a quote for a client, such as the number of litres of paint needed to paint the interior of a four-bedroom house.

The benchmarks look at things like purchases, cost of sales, work quote books, work completed per year, etc. Usefully, all three benchmarks contain examples to illustrate their operation. To use the benchmarks, all a business has to do is print out the benchmarking tables relevant to its trade and insert the relevant information in the “Your business” column.

The benchmarks are a guide, and the tax office understands there may be times when business performance could be outside these benchmarks for valid reasons. However, the Commissioner has warned that consistent, long-term performance outside a benchmark “could be a sign of non-compliance”.

For example, if the income reported by a business is consistently less than the industry benchmark, it could indicate a business is not declaring income properly. A query from the taxman is likely to follow.

In a very recent pilot exercise, the tax office wrote to or phoned 500 taxpayers, advising them that matching of their tax records against other information available to the tax office suggested they might not be reporting all their income. The tax office is offering them an opportunity to voluntarily disclose their actual income to avoid further compliance action and to secure lower rates of penalties.

Data-matching case studies

No-one should underestimate the power of the tax office’s data-matching capabilities, and this technique can be extremely useful in enforcing compliance and in countering the cash economy.

As examples, the taxman has released details of two recent cases of hidden income that were detected by its data matching activities.

Small income suspicious

A husband and wife appeared to have a good compliance history, with no money owing to the tax office. They owned a house and a liquor store valued at $780,000. They paid $360,000 in cash to purchase this business. They also owned a $65,000 BMW and recently took two long overseas holidays.

They were selected for an audit in February 2008 as the purchase of their car seemed to be at odds with tax records indicating a net household income of $17,000 a year.

Their tax agent lodged their returns and the business BASs based on information furnished by the couple.

In the course of an audit, inquiries revealed the couple transferred $40,000 overseas over a three-year period, frequently visited a local casino, and presented false income tax records to their bank to qualify for a loan.

They were unwilling to cooperate with an audit and this required the tax office to expend additional effort to establish the correct position. As a result of this effort, the tax office determined that they would have needed at least $100,000 over two years to service their outgoings.

The tax office examined their funds and expenditure as well as information provided by third parties. As a result, it found that the couple had undeclared incomes of $225,000 over four years. This led to the following consequences:

• a $60,000 income tax adjustment;
• a $20,000 GST adjustment; and
• the imposition of an administrative penalty, resulting in a further $40,000 owing.

The Commissioner says the couple has since sought an arrangement to pay the liabilities assessed against them.

He warns however that this case “may not end there”. He says the behaviours and amounts involved in such cases are matters that may warrant a criminal prosecution with the spectre of a jail term “a real possibility”.

Car the giveaway

This case involves another couple now paying off their debt with the tax office.

The couple own a restaurant. In 2005, they purchased a $76,000 Toyota Landcruiser. They were selected for an audit because their declared income was insufficient to support the purchase of the car, their lifestyle and the servicing of their home loan.

The audit detected $86,000 in undisclosed income accrued by the couple in systematically skimming from their cash sales.

These taxpayers are now repaying $25,700 in unpaid tax and penalties.

The Commissioner said the cases illustrate how the combination of state motor registry details and tax data “can bring consequences to those cheating on the community”.

Tax withholding for high-risk industries?

The Commissioner warns that the tax office is also “drilling deeper” into areas that have been over the years more prone to cash economy activity – building and construction, the taxi industry, restaurants and cafes and some areas of retailing and transport. On the basis of this information, he says the tax office is considering the desirability of introducing tax withholding arrangements for “high-risk” industries.

This would be a quite draconian step to take, as it would also affect the “honest” businesses that deal with so-called high risk industries. Compliance costs would almost certainly rise.

While no-one would argue with attempts to counter the cash economy, it is to be hoped the taxman will at least consult with business on this issue.

Read more on the cash economy, benchmarking and data-matching