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BENCHMARKING YOUR BUSINESS
27 Jan 2012
BENCHMARKING YOUR BUSINESS
This article provides an update on the small business benchmarks. Used as a tool to identify small businesses for audit and in some cases to raise default assessments, the benchmarks themselves are now being called into question.
Background
Introduced in 2008, the small business benchmarks are industry averages which allow small businesses to compare their performance against others of a similar type. The benchmarks have been formulated based on prior year returns and Activity Statements, as well as consultation with industry. There are three different types of benchmarks:
1. Performance Benchmarks - which provide data on key business ratios such as:
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Cost of goods sold to turnover;
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Cost of materials to turnover;
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Labour to turnover; and
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Rent to turnover.
2. Cash Sales Benchmarks - which show the ratio of cash sales to total sales. These apply mainly to the retail sector e.g. coffee shops, grocery stores, clothing stores etc.
3. Input Benchmarks - which show an expected range of income for tradespeople, based on labour and materials used.
There are now 107 industry benchmarks covering more than 600 000 Australian small businesses in a wide range of sectors including:
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Accommodation;
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Building and construction trade services;
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Education, training, recreation and support services;
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Food service;
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Health care and personal services;
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Manufacturing;
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Professional, scientific and professional services;
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Retail trade;
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Transport, postal and warehousing; and
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Other services.
If you wish to access the benchmarks and examine how your business compares to industry averages, go to http://www.ato.gov.au/content/00214689.htm
Their Use
When originally introduced in 2008, the benchmarks were used primarily as a tool for businesses to compare their performance against industry averages and, where the business fell outside the benchmarks, check that you have reported all income to the Tax Office and that your reporting systems are sound. This limited use of the benchmarks was at the time acknowledged by the Tax Office in one of their Practitioner Forums in November 2008 where it stated that the benchmarks were to be used exclusively as a self-assessment tool; enabling businesses to compare their performance to others in the same industry, and advised:
that the cash economy benchmarks are to be used as a guide and are not used by the Tax Office as a trigger for an audit.
Benchmarks are only used during an audit in exceptional circumstances, that is, when the taxpayer refuses to provide any
information during an audit.
Whilst the benchmarks can still be used for the purpose of self-assessment, increasingly the Tax Office has used the benchmarks as a tool for identifying small businesses for audit. For instance, in its 2011/2012 Compliance Program, the Tax Office detailed its extensive use of the benchmarks revealing that it:
- Identified more than 46 000 small businesses potentiallly under-reporting their cash income in 2010/2011;
- Wrote to more than 107 000 small businesses and their tax agents in 2010/2011 regarding their performance against the benchmarks;
- Intends to use the benchmarks throughout 2011/2012 to identify small businesses that are not complying with their reporting obligations.
Having used the benchmarks to identify businesses for audit, of recent times the Tax Office has gone one step further and used the benchmarks to issue default assessments as well as amended Activity Statements. That is, businesses falling outside the benchmarks who do not have adequate records to explain their declared income and claimed expenses, have had their income on returns, and their sales and GST on their Activity Statements adjusted up to the benchmarks - resulting in additional income tax and GST as well as penalties and interest.
Some extraordinary amendments have been issued including default assessments increasing taxpayer income by more than $100 000 resulting in liabilities raised of over $50 000 and additional penalties also running into the tens of thousands of dollars. Where this occurs and amended default benchmark assessments are issued, the onus then falls on the small business to prove that the amended Tax Office assessment (which takes them up to the benchmarks) is excessive - rather than the onus falling on the Tax Office to justify the increased amended assessment.
Under Attack
Following much questioning from industry groups and tax agents concerned with the Tax Office's use and application of the benchmarks, the Inspector General of Taxation (IGT) is currently investigating whether the benchmarks are an appropriate tool for identifying the potential under-reporting of income and for the calculation of default assessments. The IGT also plans to investigate whether the Tax Office's expectations in relation to small business record keeping are clearly communicated and reasonable. The IGT, however, is not expected to make any recommendations until well into 2012.
The lack of industry confidence in the integrity and fairness of the benchmarking process was further entrenched late in 2011 when the Tax Office announced the withdrawal of cash sales benchmarks covering 15 industries which were originally published in 2010. It was found that the data used to calculate the benchmarks was inconsistent and unreliable.
Where To Now?
Despite the IGT review, the Tax Office is still extensively using the benchmarks to identify small businesses for audit and, in some cases, as a basis for raising default assessments. In applying the benchmarks to businesses, the Tax Office process will generally be as follows:
1. Informing you in writing that your business falls outside the benchmarks (based on your returns and Activity Statements) and giving you the opportunity to provide reasons why this is so.
2. If you elect not to provide reasons why your business falls outside the benchmarks, or the Tax Office is not satisfied with the reasons provided, they may advise you that they intend to audit your business or select a sample of your transactions for closer scrutiny.
3. Following an audit of your business, if the Tax Office is not satisfied that your income and expense records justify the amounts declared on your returns and Activity Statements, they may issue default assessments (adjusting your income up) and amending Activity Statements (adjusting your GST up) in line with industry averages as indicated by the benchmarks. Penalties and general interest charge may also then be applied.
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RECOMMENDED ACTION
1. Plausible Reasons
At Stage 1 (above) if contacted by the Tax Office, then in order to prevent the process proceeding to Stage 2, be sure to provide the Tax Office with plausible reasons why your business falls outside the benchmarks. There could be many reasons for this such as higher costs or lower selling prices than others in the industry. Whatever the reason, be sure to communicate it to the Tax Office - doing so could mean the difference between the matter being closed, or the Tax Office proceeding to a full audit.
2. Good Record Keeping
In various consultations with industry groups, the Tax Office has repeatedly stated that it will not proceed to issue default assessments unless:
(a) The business falls outside the benchmarks; and
(b) Upon audit, its records are found to be unreliable or incomplete and it cannot demonstrate procedures to prove that all
income has been disclosed.
Accordingly, the best way to avoid falling foul of the benchmarking process is to keep accurate records of all your business transactions.
3. Due Diligence
Small businesses need to familiarise themselves with the benchmarks and, where they fall outside, consider whether you have declared all income and expenses. Where you are satisfied you have, further consider the reasons why you fall outside industry averages - you can then have a ready made, plausible response at hand if the Tax Office targets your business. |
For those businesses that have fallen foul of the benchmarks and have already had default assessments issued against them, it will be interesting to track the outcome of the IGT review and in particular their findings as to whether the benchmarks are an appropriate tool for identifying the potential under-reporting of income and for the calculation of default assessments. Certainly if the IGT makes a strong negative finding against the benchmarks, some redress may be available for businesses that have been issued default assessments. We will keep you informed of the IGT's findings as well as any Tax Office response to the findings.
Transparency?
One of the main issues falling out of the whole benchmarking audit process is exactly what standard of record keeping you have to meet to avoid the Tax Office issuing default assessments. This issue has been the subject of ongoing discussion between the Tax Office and industry representatives. For their part, industry quite reasonably argues that if the Tax Office is to raise default assessments on a taxpayer on the basis that they fall outside a business norm and they have poor tax records, then there should be maximum transparency from the Tax Office on both the business norm process and any evaluation criteria used to conclude that the tax records are indeed poor. At this stage there is a wealth of material available on the business benchmarking process on the Tax Office website, but little published guidelines on evaluation criteria that the Tax Office would use to ascertain that a business' record keeping is so poor as to warrant the raising of a default assessment. This issue has implicitly been acknowledged at Government level with (as stated) the IGT currently inquiring into this very matter.
Tax Office Response - New Guide on the way
As a result of industry lobbying (including through the BAS Agent Advisory Group and Tax Practitioner Forum) the Tax Office is soon to release a guide on the minimum standards it requires for small business record keeping; explicitly outlining what records you need to keep to avoid a default assessment being raised. This publication will be specific to cash economy audits, and it is hoped that this will provide some much needed clarity on precisely what constitutes adequate record keeping and the protocols and standards that the Tax Office will apply consistently across the small business sector. Upon its release, we will inform you of the name of the publication and where to access it on the Tax Office website.
Comments
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