When the Australian Tax Office (ATO) plans to review or audit your tax return, it will also notify your accountant. Your accountant will then serve as your guide in managing the process from start to finish. So what happens next, and how should you respond to an ATO audit? Are there limits to the kinds of inquiries and requests for information that the ATO can make?

While we all appreciate the vital role the ATO plays in keeping our tax system and taxpayers in check, an ATO audit is an unpleasant experience. Even the most law-abiding citizen can fall into the clutches of the taxman. Ultimately, ATO audits are not reserved for wrongdoers. It can happen to any tax-payer, regardless of industry, business structure, record-keeping practices, or otherwise – we’re all potential targets.

Bottom line: ATO audits are painful. They require time and money to resolve, irrespective of your level of wrongdoing. So even without penalty or debt, the costs of professional fees can add up. Unfortunately, clients do not always see things this way and may erroneously conclude that their accountant is to blame. In reality, the ATO audits far more problem-free tax returns than those that end in fraud or evasion.

What do ATO audits, reviews, or investigations look at?

• Cashflow boost
• Income declarations
• Expenses relating to self-education
• Business Activity Statements
• Claims surrounding GST
• Deductions relating to work
• Superannuation
• Employer obligations
• Deduction relating to motor vehicles

What does an ATO audit warning letter mean?

Unlike a review, investigation, or audit, a warning letter is more like a notice of further potential action. It indicates to the taxpayer or accountant that there is a red flag or discrepancy in the tax return, and encourages an internal review to rectify any mistakes in the accounting or claims. If nothing sticks out upon review (note: the ATO does not always spell out exactly what triggered the notice) consider a professional opinion.

If nothing needs amending, then move on. When you miss something that the ATO pulls you upon, you’ll need to amend the return with the ATO. Tax returns that are two years or older require special permission to revise and open. Accountants, however, have special access to make changes to tax returns made earlier.

What triggers ATO audits?

Every year, the ATO leverages data to cross-check your tax declaration against other returns with comparable metrics across similar industries. In the first instance, the ATO rarely invests personnel to investigate a particular return, relying heavily on automation of algorithms to trawl through the millions of assessments. Will this system be right 100% of the time? Not a chance. Is it improving in accuracy and detection every year? You can bet on it.

As we know, the ATO indicates its areas of interest for a particular tax year. Given the pandemic and various stimulus packages, the ATO will be shining light on businesses and individuals that benefited from one or more of these initiatives.

In recent years gone by, the ATO has focused on undeclared taxable income (including overseas earnings) and work-related expense claims. The emergence of cryptocurrencies, for example, and any resulting capital gains generated, also drew specific ATO attention in its pursuit to claw back tax unsubstantiated tax revenue.

Other ways the ATO detects anomalies is through industry benchmarks. For instance, if you are well below the averages for income in your industry, the ATO may choose to look further into your declaration. Some industries have rested on their laurels in identifying themselves as cash-only. This is seldom adopted nowadays and more often the reverse is true, i.e. “cash not accepted”. In the eyes of the ATO, there is no reason for a business to be cash-only in its trading.

Data-matching technology

The ATO’s data-matching technology will not (yet) distinguish between innocent and intentional mistakes. If you inadvertently do the wrong thing, the ATO takes an understanding approach. Generally, the ATO accepts that tax-payers plug the wrong numbers in by accident. In these circumstances, discretion has proven the best approach to encouraging future and ongoing compliance with the Australian tax system. Some accountants, knowing that the ATO audits are not entirely avoidable, work with tax audit insurance providers to provide clients with an added layer of risk management.

The takeaway here: the ATO will approach every situation differently. Having an accountant assist you in lodging your returns is immeasurably valuable for a business. An ATO audit can be complex. An accountant’s attention to detail means no further discrepancies or anomalies emerge during the process.

What does the ATO audit process involve?

You have just received an ATO audit letter notifying you of an impending ATO audit.

What happens next? The ATO will organize a meeting and confirm the meeting agenda in writing. This is known as the audit management plan.

During your meeting, the ATO will establish the audit scope, which defines the timeline of activity to be audited. The audit officer will provide a risk hypothesis, which is the area of concern about which the ATO wants more information. In your meeting, you will agree on timelines and the preferred communication method.

How important is having an accountant during an ATO audit?

Not having an accountant during an audit is like not having legal counsel during a criminal investigation. Apart from the reality that this area is specialized, the process is protracted at the best of times. An accountant will be much more efficient and accurate in their management of the ATO audit, having navigated the process many times before. While the professional fees of your accountant (or tax lawyer for that matter) may be covered by a robust audit insurance policy, dealing with this yourself will not.

From a legal perspective, if you’re initially managing this yourself, ask as many questions as possible on your call with the ATO. Enquire about the scope of the ATO audit. Best to avoid making statements outside answering the ATO officer’s direct questions. Remember, anything you say could be used against you. Try not to provide additional information until you have first spoken to a professional.

The ATO has the legal legs to summon information under the Taxation Administration Act, 1953, however still needs to have a reason to request any information. Ask that the ATO gives you the audit scope and any specific requests in writing. It will be easier to hold them accountable. Understand that ATO auditors are not looking to bust you. Instead, they want you to understand your obligations and rectify any errors made while navigating the complex terrain of Australian tax law.

Rules and stages of the ATO audit

ATO audits can carry on for months. You and your accountant can contact your case officer, the details for whom will be provided by the ATO when they put together your audit management plan. Remember, the initial scope of the audit can change. The risk hypothesis can expand. Your accountant or legal counsel will be indispensable in these moments of deciding how (or whether) to respond to further requests for information.

Time limits to ATO audits?

It is common practice to keep hard or soft copy records of your tax returns for five years. No excuses.

The end of the ATO audit process?

You or your accountant will eventually get the ATO’s final decision, which will cover:

• The facts
• The “risk hypothesis”
• Your case or challenge to the facts and hypothesis
• Any relevant laws being applied under the ATO audit process
• Any areas of your tax assessment under review
• Any resulting interest and penalties
• Your ATO officer’s contact details

At this stage, you will want to make final comments and challenges before the ATO rules on the matter. You can also ask for there to be an independent review of your case to have full confidence that the case has been handled impartially, the outcome of which is made about one week following the final decision.

Disagree with the ATO audit outcome?

In some cases, you will fervently object to the decision made against you. If this happens, you can seek alternative dispute resolution whereby a third party assists to resolve the matter. The ATO aims to avoid long and drawn out, litigious claims and often will consider early settlement options instead. Otherwise, there are vehicles of in-house facilitation available, which involves bringing in an impartial facilitator to help resolve the matter. In any case, you can challenge the ATO’s decisions. These challenges are put into writing and provided to the ATO to then be reviewed by the Review and Dispute Resolution Department – an objective body separate from the ATO.

Does software make a difference?

Thriday's automated accounting software is a proactive defence against tax audits because it tracks deductions automatically to minimise discrepancies and increase compliance. If an audit were to arise, Thriday digitally stores all necessary records, facilitating a seamless and well-prepared response. By consistently recording precise financial documentation, Thriday empowers businesses to not only reduce the risk of audits but also navigate them with confidence, ultimately streamlining the process and mitigating potential complications. 

Takeaway: Minimize ATO audit risk with an accountant, and manage professional fees with audit insurance

Without question, the point to be taken away here is the absolute indispensability of accountants and tax agents in dealing with an ATO audit. The ATO does not know your business as intimately as you will, and while the data-matching technology is impressive and often accurate, mistakes are not unheard of. It is important that you know your rights and understands your responsibilities in dealing with the ATO effectively to minimize time and financial investment in paying the professional fees incurred during the audit process. If you are considering tax audit insurance for yourself, your business, or your clients, speak with the AuditCover team.