These are the words nobody ever wanted to hear, but have you ever wondered how the ATO identifies who to audit?
One positive is that the ATO is very upfront when it comes to who they intend to target. Every year they publish small business benchmarks that outline what a typical business ‘looks like’ in different industries. If your business falls outside of those benchmarks, the ATO is likely to take a closer look at why that is.
Falling outside of these ATO benchmarks might not indicate a tax related problem. It might mean that your business has a different business model to the norm or is performing poorly relative to others in the industry.
If your business does fall outside of the benchmark however, it is important to ensure that the reasons why can be clearly articulated (and preferably documented) and the reason for those differences is not tax evasion. If the business cannot prove that they are outside the benchmarks, the ATO is likely to simply apply the benchmark ratio and issue a revised tax assessment. This is after a review or audit has occurred and can also come with significant penalties and interest depending on the circumstances.
We find that the main areas the ATO look at are:
- cost of sales to turnover (excluding labour)
- total expenses to turnover
- rent to turnover
- labour to turnover
- motor vehicle expenses to turnover
- non-capital purchases to total sales, and
- GST-free sales to total sales.
For example, for a veterinary practice with a turnover between $300,000 and $800,000, the cost of sales to turnover ratio is expected to be between 25% and 29% (averaging at 27%), and average total expenses are 78%. The cost of labour to turnover ratio is between 21% and 29% and rent is between 5% and 8%.
These ATO benchmarks are based on industry wide research that the ATO conducts and as such they are also a useful tool for anyone wanting to understand what is typical in their industry and how they perform against the average. It might also indicate opportunities for improvement and where the business is falling behind its competitors.
Paris Financial can assist you with a review of your business if you feel that your business may be operating outside the industry benchmarks or simply not performing as expected.
Ken Burk, Partner, Paris Financial