The ATO’s booby trap exposed

The ATO runs a record keeping hustle which you are already on the wrong side of.  However, if you know about it you can, at least, not be surprised when it happens.  A bit like knowing that you will probably get your pocket picked in Rome.  It might happen anyway but if you know about it you can at least prepare or do some planning around it.

This is a tale of three competing forces: the law, the computer and the ATO.

Here’s how it works:

There is a section in the tax law that says you need to keep sufficient records to be able to show how you worked out your taxes.  Its section 262A of the Income Tax Assessment Act 1936 if you want to look it up.

When you read this section you might rightly think that if you have your accounting records and invoices this should be enough to show how you worked out your taxes.  This makes sense but it is also incorrect.  This is the first part of the booby trap – lulling you into a false sense of security.

Let me explain why.

The ATO is only interested in your records if you are being reviewed or audited.  Otherwise, the only person who looks at the records is your accountant, you, or maybe someone who wants to buy your business.  You and your accountant look at the records for what they are.  Your accountant might even read the taxpayer charter which says the ATO looks at the records for what they are and presumes that they are correct unless they have reason to think otherwise.

This is the second part of the booby trap and where the computer comes in – you’ve acted on the false sense of security and you are now exposed.

The computer activates the booby trap.

The computer works out who should be audited based on certain parameters that are kept secret but are also obvious at the same time, for example if your business isn’t meeting the benchmarks of profitability etc.  Yes, if your business isn’t doing well, then you are at a higher risk of an audit.

When the computer picks you for an audit, the auditor takes that as a signal that something is wrong.  The underlying assumption is that your business should be more profitable.  The ATO smells a rat.

So what are the reasons why your business isn’t profitable – from the ATO perspective.  Here are three common reasons:

  1. You collect cash which you don’t declare, hence its not on the books
  2. You have two sets of records, one is real and the other is fake and you show the fake records to the ATO
  3. You spent all the cash on gambling, alcohol or drugs

The auditor’s job is to prove that this is true.

If the auditor can’t prove this is true, they have two choices:

  1. Go against the computer and say you are actually OK – but why would they risk their career for you, a random person they don’t even know. After all, the computer says you’re dodgy.
  2. Go with the computer and change your taxes, add in some profit, and get you within the benchmark. This reinforces the benchmark and allows the ATO to say that all businesses fall within the benchmark, which allows them to then bring other struggling businesses into the benchmark and so on in a self-reinforcing pattern.

So they just hit you with some extra tax.

It won’t surprise you to know that the people hit with these are struggling businesses because they have lower profits and are below the benchmark.  All this does is finish them off.

The auditor knows this.  They know that the person doesn’t have the money or resources to defend themselves so the audit result stands.  The person goes broke and the benchmark is preserved.  The auditor’s results are never tested.  The ATO says they deserved to be broke because they were dodgy.

Some people have money to try to object, but most people will give up at this stage.

But what about record keeping you ask?

Well, lets put it this way, the ATO doesn’t want to believe your records and will not.  Here are some questions that the ATO may ask, and will ask you to prove:

  1. How do they know all your cash has been declared?
  2. How do they know that your business’ purchases weren’t for personal use?
  3. Why don’t you have a valid tax invoice for all of your expenses
  4. How do they know your bank statement hasn’t been forged

Can you see the booby trap?

Here is what’s happened – you’ve kept the records used to work out your taxes and thought the ATO would be willing to rely on them.  However, the questions the ATO ask are so nebulous that the normal records you keep can’t help you.  You can’t go back in time and sort all of this out.  You’re asked to prove the impossible and when you can’t, its down to poor record keeping.  If only you had kept good records that the ATO could rely on.

You told them you don’t know much about taxes and rely on an accountant – all the more reason for them to not rely on your records because you didn’t understand them.  You told them you did an accounting course so know a little about accounting – all the more reason for them to penalise you for not keeping all of the records because you should have known better.  You can’t win.  You’re trapped.  The booby trap has been sprung.  All you can do now kick their ass if you aren’t feeling too demoralised to do it.

Adam Ahmed is an Australian international tax lawyer. Adam has over a decade of experience working at 3 of the big 4 accounting firms and one of the top tax law firms in Australia. He is currently the managing director of Adam Ahmed & Co.

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