The ATO is very upfront when it comes to their compliance activity. 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.
How Does the ATO Identify Audit Targets?
Falling outside of the typical business 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’s important to ensure that the reasons why can be clearly articulated and documented. And obviously it’s best if the reasons for those differences don’t include tax evasion. If there’s no proof as to why the business is outside of the benchmarks, the ATO is likely to simply apply the benchmark ratio and issue a revised tax assessment.
In determining whether your business warrants closer scrutiny, the ATO look at:
- 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 $300,001 and $800,00, the cost of sales to turnover ratio is expected to be between 25% and 29% (averaging at 27%), with average total expenses are 78%. The cost of labour to turnover ratio is between 21% and 29% and rent is between 5% and 8%. Pretty specific stats that clearly flag the outliers.
On a positive note, the benchmarks 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 show where the business is falling behind its competitors. You can find out more about the ATO’s Small Business Benchmarks here.
So what’s the best way to avoid an audit?
Your best protection is preparation – make sure you have your financials in order should the ATO come knocking! Unfortunately though, with 600 million pieces of third-party data helping the ATO track activity and income, there’s never any guarantee against an audit – no matter how accurate your financials or how good an Accountant you have! So if you’re concerned you may be audited, you may want to consider Audit Insurance – it’s a great way to protect yourself against unbudgeted professional fees incurred during the audit activity process.
If you need help getting your financials ready for the tax man, send us an email or call us on (03) 9887 8751 to make an appointment. And if you’d like more information about our Audit Insurance policy, just give us a call!