The cash economy

2.1 Business activity that is not reported as income for taxation purposes is referred to as the cash economy (or 'underground economy'2) by revenue administrations globally. The ATO considers the cash economy as a major tax integrity threat under its Enterprise Risk Management Framework, defining the risk as a 'failure to identify and respond to major threats posed by the cash economy which have the potential to undermine community confidence in the integrity of the system.'3

2.2 On its website, the ATO describes the cash economy as occurring when 'businesses deliberately use cash transactions to hide income to avoid paying tax.' The website further states that cash economy activities include businesses:

  • paying wages 'cash-in-hand';
  • skimming some or all of the cash takings;
  • running a part of their normal business activities 'off-the-books';
  • not reporting the value of goods and services provided in exchange for other goods and services; and
  • operating underground — that is, avoiding their tax and superannuation obligations by not registering their business or lodging returns.4

2.3 For the purposes of its communication strategy,5 the ATO identified the following conditions that must exist for a business to underreport its cash income:

  • Access to cash — the business must have access to cash transactions. Typically these businesses transact a significant volume of cash or have the opportunity to convert part of their income to cash.
  • Opportunity — individuals operating the business must have the opportunity to hide cash transactions. Some businesses, particularly those which are smaller, do not have controls to ensure that all sales are recorded. Omitted cash income most commonly occurs where the beneficiary of the tax evasion, generally the business owner, controls some part of the cash recording and handling processes.
  • Motivation — the decision to engage in non-compliant behaviour is made by an individual or group of individuals in order to gain some benefit. Those participants are motivated to engage in such behaviour by a range of 'drivers', which may change over time as individuals' circumstances change.

2.4 The ATO has estimated that there are 1.4 million businesses operating within the 'cash business segment'.6 However, it is unknown how many within this segment would actually underreport their income.

The ATO compliance strategy for the cash economy

2.5 In its Compliance Program 2009-10, the ATO said:

The present economic climate has increased competitive pressures on small businesses and created an environment where some will seek an unfair advantage. It is important that we support honest businesses by taking firm action against those seeking an unfair advantage.

When many in the business community are doing it tough, it is even more important that the system is seen as fair and equitable.7

Compliance detection and verification methods

2.6 In furtherance of this goal, the ATO has developed three main methods ultimately directed towards detecting the underreporting of income in the cash economy and verifying the income that is reported. These methods are:

  • cash economy risk modelling;
  • data matching; and
  • performance benchmarking.

2.7 Each method is discussed below.

ATO cash economy risk modelling

2.8 The ATO cash economy risk model is based on a set of 'business rules'. It was developed over a number of years using a number of tests to identify probable omitted income. The model was developed by a review of completed case work and debriefs of auditors. The model is also continuously updated in this way. The rules identify the risk of omitted income based on information contained in ATO systems, industry information and third party data. A total risk score is calculated which the ATO uses as a basis for further action. The model covers the 1.4 million businesses in the cash economy population.8

ATO data matching

2.9 Data matching seeks to compare information from third party sources, such as other government agencies, banks, lands title offices and motor vehicle registries, with those reported by taxpayers in their income tax return. Inconsistencies may be indicative of underreported income upon which the ATO may take follow-up action.

2.10 Recently, the ATO has also approached data matching for the cash economy on an industry basis. For example, the ATO has targeted the building industry and the coffee shop industry. In the case of the coffee shop industry the ATO has acquired data from coffee suppliers in order to identify purchasers of coffee over a certain threshold.9 The ATO then compares these purchasing records with what was reported in the tax returns and activity statements of businesses to identify:

Businesses that do not report or under-report their sales.

Businesses that may be running a part of their normal business activities off the books or operating underground by avoiding their obligations to register and lodge returns.

Risks and trends of non-compliant behaviour by those involved in the coffee industry.10

Performance benchmarking

2.11 The ATO reports small business performance benchmarks as:

financial ratios developed to help you compare your performance against similar businesses in your industry. The benchmarks provide guidance on what figures we [the ATO] would normally expect a business in a particular industry to report.11

2.12 The ATO advises that the purpose of these benchmarks is to identify businesses potentially not correctly or completely reporting their business income and expenses. In this respect, the ATO considers they provide a guide for businesses to compare their performance against others in their industry. The ATO also seeks to make it clear that good record keeping is an obligation for all businesses and to take the individual circumstances of taxpayers into account.12 Businesses significantly outside of the benchmarks can expect a form of ATO engagement to better understand the taxpayer's specific position.

2.13 The number and types of ATO benchmarked industries is indicated on the 'Small business benchmarks' page of the ATO website.13 Out of the 1.4 million taxpayers that are considered by the ATO to be in the cash economy, the small business benchmarks cover over 100 industries encompassing 900,000 businesses.14 Of these, the ATO has identified 76,000 businesses with financial performance that falls 'significantly outside' the benchmark range for their industry. The diagram below visually represents this break-up.

2.14 In this diagram, it is important to note that even if a taxpayer is not selected for compliance activity based on the benchmarks, they may still be subject to a cash economy audit or other compliance activity based on the cash economy risk model or other specific cash economy strategies such as data matching.

Figure 2: Where benchmarking activities fit in the cash economy

Diagram explaining where benchmarking activities fit in the cash economy. Out of the 1.4 million taxpayers that are considered by the ATO to be in the cash economy, the small business benchmarks cover over 100 industries encompassing 900,000 businesses. Of these, the ATO has identified 76,000 businesses with financial performance that falls ‘significantly outside' the benchmark range for their industry.

Source: (a) From the ATO Compliance Program 2011-12. (b) Australian Taxation Office, ATO Small business benchmarks: Promoting a level playing field for Australian small business, November 2011, supplied by ATO 24 November 2011.

Note: Diagram not to scale.

2.15 Performance benchmarking is the focus of this review and issues arising in relation to it are discussed in the following chapters.

Governance of and funding for the ATO small business benchmarks

2.16 The ATO's 'Cash Economy' stream of the Tax Practitioner and Lodgment Strategy (TPALS) business line is largely responsible for managing the risk and ensuring compliance by taxpayers in the cash economy sector. The delivery of strategies directed towards this aim, including small business benchmarks, is overseen by the ATO's Cash Economy Leadership Group, comprising ATO senior executives and directors, who meet on a monthly basis. This group is responsible to the TPALS Risk Management Steering Committee, which reports to the TPALS Executive and ultimately to the ATO Executive for delivery of the strategy (see Appendix 2). This oversight is informed by a number of other internal groups who are responsible for specific aspects of the cash economy strategy, including benchmarking.

2.17 In the 2009 Federal Budget, the government allocated funding to:

Address the anticipated expansion of unfair competitive practices such as cash economy participation, non-compliance with employer obligations for income tax and superannuation and phoenix activity, with increased visibility in the community.15

2.18 As part of this funding, an allocation of $9.965 million over four years (2009-10 to 2012-13) was made to develop small business benchmarks and conduct compliance activities based on these benchmarks (see Appendix 3).

2.19 As a result, the small business benchmarking strategy was predicted to raise $18.5 million. The table below provides the basis for this estimate.

Table 1: Tax Revenue Estimates Summary
Promoting a level playing field for Australian small business — business performance benchmarks
  2009-10 2010-11 2011-12 2012-13 Total
Activities to be performed (comprised of assistance and compliance) 6,425 6,425 6,425 6,425  
Revenue ($m) 4.1 4.4 4.9 5.1 18.5

Source: Cash Economy — Budget Initiatives document — summation supplied to IGT on 19 June 2012.

2.20 The ATO has set out desired outcomes and success goals to measure the effectiveness of the small business benchmarking program. It identified the desired outcomes as:

  • the ATO demonstrates it has the ability to effectively deter, detect and deal with the cash economy thereby increasing willing participation and community confidence in the integrity of the tax system;
  • taxpayers and their registered agents understand the importance of recording and declaring all income, expenses and other tax related transactions; and
  • intermediaries champion willing participation in the taxation and superannuation systems.

2.21 The ATO has identified the success goals as:

  • taxpayers more accurately report all income, expenses and other tax related transactions;
  • taxpayers demonstrate more timely lodgment of their returns and payment of their taxes;
  • an improved ATO ability to deter and detect cash economy participation through the small business benchmarks and appropriate action being taken when identified; and
  • registered agents and other intermediaries becoming more willing to champion the small business benchmarks.16

2.22 The ATO's small business benchmarks cover a range of businesses with turnovers below $15 million17 and, therefore, affects taxpayers from both the micro enterprises and the small and medium enterprises (SME) market segments. 18

Challenges and pressures

2.23 Effectively dealing with the cash economy can present many challenges for revenue authorities, including the following:

  • underreporting of income can be difficult to detect due to the 'hidden' and dispersed nature of the economic activities concerned;
  • identifying the most revenue-productive targets can be difficult due to the relatively large number of participants and the small amounts of tax involved (however, given the large numbers involved, the aggregate tax revenue at stake is sizable19);
  • many participants have poor books and records and in some cases may not even be registered with the revenue body;
  • even where some unreported transactions of a participant are detected, ascertaining the full extent of their unreported income for a fiscal period may necessitate exhaustive and often time-consuming inquiries by the revenue body;
  • even where unreported income is assessed to the participant concerned, there may be difficulties in actually collecting the amounts of tax, interest and any penalties that are due;
  • detecting and dealing with such non-compliance provides no guarantee that it will not be repeated into the future; and
  • compliant taxpayers may become less compliant where they feel that the underground economy is not being properly addressed and that, as a result, they bear an unfair share of the tax burden.20

2.24 Taxpayers and their advisors have also suggested to the IGT that a greater understanding of the pressures experienced by businesses in these segments was needed in designing relevant compliance activities. Although these pressures were not purported to justify non-compliance with the reporting obligations under the law, they were seen as impacting on businesses' ability to ensure compliance and include those set out below.

2.25 Firstly, regulatory costs, including tax compliance costs, are significant and generally borne regressively by micro and small businesses. Whilst many businesses may use the services of a bookkeeper and tax agent, certain taxpayers could consider the cost prohibitive and seek to manage their own record keeping and return preparation. This has the result of taking the business operator away from carrying on more productive activities. This situation can be contrasted with medium to large businesses that may have external or in-house accounting and tax resources the cost of which may be a lesser proportion of their operating expenditure.

2.26 Secondly, micro and small businesses operate in a more marginal or highly competitive environment that increases pressure to find cost savings. These savings, for some, may include attempts to reduce the overall tax compliance burden. This may be particularly so if they perceive an uneven playing field whereby their competitors are gaining an unfair advantage from tax non-compliance.

2.27 Thirdly, tax 'competency' in the micro and small business market segment is highly variable. Research21 commissioned by the ATO in 2008 also indicated that 13 per cent of micro businesses had neither engaged an accountant nor a bookkeeper. Of that population, 31 per cent reported not using an electronic record keeping system. In terms of knowledge, 21 per cent of micro businesses rated themselves as knowing only a little about their tax obligations and entitlements. However, it should also be noted that 93 per cent of micro enterprises use registered tax agents to lodge their tax returns and 50 per cent to lodge their activity statements.22 As such, the 'language' and communication required to engage with these taxpayers needs to be carefully considered in design and delivery to be effective.

2.28 Lastly, operators run their businesses for a variety of reasons and motivations. As such, some may not dedicate as much time to certain business management aspects as other operations. Some may also run their own business for lifestyle and family related reasons and thus do not run their business purely for profit maximisation.

2.29 As discussed further below, the ATO advises that it seeks to take these factors into account through a differentiated approach to its compliance activities in relation to this market segment.

Risk based approach to compliance activities

2.30 The ATO uses a risk-based approach to identify taxpayers or transactions which it considers represent a higher risk of non-compliance.

2.31 This is based on the premise that the Australian self-assessment system requires that the majority of taxpayers voluntarily comply with their taxation obligations. Auditing all 1.4 million businesses operating in this market segment would be impractical with the cost of pursuing every cent of revenue not being commensurate to the amount actually collected.23

2.32 In dealing with the cash economy, the ATO applies the 'compliance model' (see Figure 3 below), which seeks to treat taxpayers differently according to their different behaviours and attitudes towards compliance. It does this by adopting a variety of compliance strategies, approaches and products.

Figure 3: The ATO compliance model

Graphic establishing the ATO compliance model.

View image enlarged

2.33 The ATO compliance model includes a diagram known as 'BISEP', which recognises that taxpayer compliance behaviour is influenced by many factors — business, industry, sociological, economic and psychological. By understanding what drives non-compliant behaviour, the ATO can influence taxpayer behaviour by understanding how these factors affect compliance behaviours. For example, if a taxpayer operates in an industry where non-compliance is systemic at the industry level, the ATO may work with industry bodies to develop strategies to improve compliant behaviour at the broad level.

2.34 Furthermore, the ATO's differentiated approach to compliance means that the intensity and visibility (and usually compliance costs) of compliance activities generally increase with the risk.

2.35 This approach can be described as a type of 'funnel', where large numbers of taxpayers are risk profiled at the top (see Figure 4 below). Usually, such profiling takes place within the ATO without the need to contact the taxpayer, since it relies on information the ATO already has, such as that obtained from tax returns and activity statements, or information that is accessible from third parties, such as that obtained from financial institutions or other government agencies. Thus, this level of verification is effectively invisible to the taxpayer and the cost of compliance is low.

2.36 For taxpayers identified as having greater risk, the ATO undertakes more specific verification activity. This may involve the ATO contacting the taxpayer for further information to verify compliance. It is often at this point that the verification activity becomes visible to the taxpayer. Informal information requests can be low intensity, whilst formal requests, such as in audits, can be regarded as high intensity.

2.37 Since more intensive activity usually requires more ATO resources, the number of taxpayers affected decreases. Also, as the intensity of the compliance activity increases, the compliance costs tend to rise with it.

Figure 4: Differentiation in intensity and visibility of verification activities24

Diagram setting out differentiation in intensity and visibility of verification activities.

2.38 It should be noted that all taxpayers would normally be expected to incur a 'baseline' level of compliance costs in administering their tax affairs, such as maintaining adequate evidence of their income. Some taxpayers may seek to defer those compliance costs by, for example, not keeping records or failing to take care in accurately completing their tax returns. Conversely, taxpayers may be subject to additional compliance costs as a result of engagement from the ATO. Taxpayers who have sought to defer their baseline compliance costs by not maintaining adequate evidence of their income may subsequently find themselves incurring higher compliance costs if audited than a taxpayer who maintained adequate evidence.

2.39 The manner in which ATO compliance activities are conducted also has a direct bearing on taxpayers' compliance costs, both baseline and additional.

2.40 Both the ATO compliance model (Figure 3) and the ATO differentiation diagram (Figure 4) above highlight the importance of 'proportionality'. That is, the visibility, intensity and compliance costs imposed on the taxpayer from the compliance activity should be proportionate to the risk the taxpayer poses to the revenue and the integrity of the system. Since both models show a decreasing number of taxpayers affected by more intense compliance action, it is implicit that ATO risk assessment approaches should be just as successful at excluding compliant taxpayers from escalating compliance costs as they are at targeting non-compliant taxpayers.

The bottom of the ATO compliance model

2.41 The ATO compliance model assumes that the majority of taxpayers adopt the 'willing to do the right thing' attitude. These taxpayers are placed at the bottom of the ATO compliance model.

2.42 The ATO has strategies to 'make it easy' for these taxpayers operating businesses in cash economy industries to comply with their tax obligations — sometimes called 'help and educate' activities by the ATO.

2.43 One means by which the ATO executes these types of strategies is to make information and education products available from the ATO website. For example, the records a small business should keep. Taxpayers can also download and use the Record Keeping Evaluation Tool which helps businesses self assess the quality of their record keeping.25 From March 2000 until July 2010, the ATO also provided e-Record, which was a free electronic record keeping system. This product was withdrawn as it was no longer compatible with commercial record-keeping systems. Taxpayers were advised to adopt commercial accounting software programs.26

2.44 The ATO also 'makes it easy to comply' at the bottom of the model through the availability of various ATO assistance visits. For example, the Small Business Assistance Program is taxpayer-initiated and is covered by the 'Commissioner's guarantee', meaning that any information provided to the ATO officer is confidential and cannot be used for any other purpose. Another example is through outbound contact to taxpayers in cash economy industries as part of the Cash Economy Program. These visits, aimed at new businesses, are not obligatory but taxpayers are encouraged to take advantage of the opportunity. The visits are not covered by the Commissioner's guarantee, however the intent of the visit is to provide the taxpayer a better understanding of record keeping. During these visits the ATO does not examine taxpayers' records for compliance purposes. Whilst these visits are a low intensity and low risk experience for the taxpayer, it is quite resource intensive for the ATO to undertake since it is a field based activity.27

2.45 The ATO also runs free seminars and workshops for small businesses, including those who are thinking of starting a business and those who have just started. These include 'record keeping workshops'. These seminars are run by the Community Education and Assistance section of the ATO, rather than the Cash Economy stream.28 Taxpayers can access the ATO website to either make a booking for their own group at their own venue or attend a scheduled seminar. The ATO website currently indicates that:

Due to competing priorities, we are currently unable to schedule any seminars. This will be reviewed over the coming months, with the aim of recommencing the seminars as soon as possible. We apologise for any inconvenience.29

2.46 The ATO has advised, however, they aim to recommence these seminars from July 2012.30

The top of the ATO compliance model

2.47 At the top of the ATO compliance model the ATO targets those who have decided not to comply with their tax obligations. These include taxpayers who have deliberately underreported their income. One of the main tools the ATO uses to detect such taxpayers is the 'cash economy risk model' which essentially uses a data matching method (described above) to ascertain whether businesses are reporting unrealistic levels of income.

2.48 Taxpayers identified under this model are usually subjected to a 'cash economy audit'. This is a field based activity which is held at the taxpayer's or tax agent's premises.31 These audits are intensive both in terms of scrutiny and required ATO resources. Due to such intensity, these audits are only performed on higher risk taxpayers.

The middle of the ATO compliance model

2.49 In the middle of the ATO compliance model, the ATO targets compliance activities of lesser intensity than those directed towards taxpayers with a higher risk of non-compliance. An example is the ATO's desk based correspondence audits which are selected on the basis of a business's financial performance when compared with others in the same industry — that is selected on the basis of the small business performance benchmarks.

2.50 Under the benchmarking strategy, the ATO uses the taxpayer's financial performance variance from their industry benchmark as the main basis for determining the administrative treatment to which taxpayers will be subjected. The treatments vary from a help and educate letter, to a phone review, or a correspondence audit. Generally, the greater the variance, the more intense the treatment. That is, the ATO uses benchmark variance as a key risk indicator for determining a taxpayer's place on the compliance model.

How ATO small business performance benchmarks are developed

2.51 The ATO develops small business benchmarks for use in any particular year based on data from income tax returns and activity statements lodged with respect to that year. For example, in establishing benchmarks relevant to the 2008 income year, the ATO used income tax returns and activity statements lodged with respect to 2008.

2.52 The data from the returns and activity statements are selected for the benchmarks if they relate to taxpayers in ATO-identified cash economy industry segments. The data is then grouped according to 'ATO benchmarked industries'. These ATO benchmarked industries are derived from the industries set out in the publication ATO Business industry codes32. These 5-digit codes are an ATO adaptation of the Australian Bureau of Statistics' (ABS) ANZSIC codes (4-digit based). The ATO has adapted these ABS ANZSIC codes by adding a fifth digit to allow for a greater level of distinction of industries. For example, the 4-digit ABS ANZSIC code 4121 covers 'Fresh Meat, Fish and Poultry Retailing'. The ATO has used the fifth digit to distinguish between seafood, poultry and meat retailing.

2.53 In many industries, the ATO has not used the fifth digit to distinguish between sub-industries belonging to a code. For example, the ATO business industry code 41290 covers 13 listed types of 'Specialised food retailing' businesses such as bakeries, cake retailers, smallgoods retailers and confectionery retailers. None of these listed business types have their own particular 5-digit code. It is shared with the other 12 listed business types. By listing the 13 business types, the ATO assists those listed businesses to identify themselves as belonging to that shared 5-digit code. Appendix 4 provides more information about how the 4-digit ABS ANZSIC codes relate to the 5-digit ATO business industry codes.

2.54 The ATO allocates businesses into ATO benchmarked industries using an automated process. The process initially uses the ATO business industry codes that taxpayers or their tax practitioners enter on the income tax return. It then examines, using keyword searches, the business descriptions and trading names provided by the businesses in their income tax returns and registration details in order to exclude businesses that appear to have entered an incorrect business industry code.

2.55 For the 2008 and 2009 income years, the ATO extracted data from the income tax return fields, such as cost of sales and turnover, and developed the ratios, such as cost of sales/turnover. For the 2010 income year onwards, the ATO also extracted data from activity statements to create a non-capital purchases/sales ratio, and a GST-free sales/total sales ratio.

2.56 These ratios are expressed as percentages. The ratios for each ATO benchmarked industry are collated and analysed for trends in turnover. That is, businesses in the same ATO benchmarked industry may tend to have different ratios or ratio ranges depending on their turnover sizes.33 The following scatter graph shows that the ratios can concentrate in certain areas, and that this concentration may vary depending on the turnover.

Figure 5: Cost of sales to turnover ratio versus turnover for an ATO benchmarked industry34

Scatter graph showing the cost of sales to turnover ratio versus turnover for an ATO benchmarked industry.

2.57 Once the data set of ratios has been determined and turnover ranges are assigned, the data set for each ATO benchmarked industry is cleansed of inappropriate outliers using the Mahalanobis Distance technique35 which seeks to both identify and exclude taxpayers who:

  • are unlikely to belong to that data set (that is, they may be in the wrong industry due to incorrect information on the income tax return or ABN application); or
  • have ratios that are so far from the norm that there is a likely measurement error (which could be due to incorrect or inconsistent underlying information presentation in the income tax return labels, affecting ratios).

2.58 The turnover ranges are then reviewed to ensure they reflect the distribution of results after the statistical outliers have been excluded. The ranges are limited in number, usually three and sometimes two, to increase the usability of the benchmarks.36

2.59 The ATO then identifies a pre-set proportion of the population around the mean, the upper and lower limits of this population representing the benchmark ratio range for that industry.

2.60 The benchmark ratios are then tested to determine whether a given benchmark ratio qualifies as a 'key performance benchmark' or an 'information performance benchmark'.

2.61 Where the population is normally distributed and homogenous and at least 50 per cent of the businesses in that ATO benchmarked industry report the source data in the tax return, the benchmark ratio based on that data qualifies as a key performance benchmark. Where the source data is reported by less than 50 per cent but more than 25 per cent of the population, the benchmark ratio based on that data qualifies as an information performance benchmark.

2.62 Where more than one benchmark ratio meets the criteria of a key performance benchmark, 'then industry knowledge and intelligence is utilised to select the most accurate predictors of turnover for an industry'.37

2.63 The benchmarks are then published on the Small business benchmarks section of the ATO website.38 Appendix 5 contains an example of a small business benchmark webpage for delicatessens.

2.64 On the ATO website, key performance benchmarks are referred to as 'key benchmark ratios'. Key benchmark ratios are those ratios which the ATO considers to be 'the most accurate predictor of business turnover for each industry.'39 The ATO therefore uses these key benchmark ratios for risk identification purposes. It may also use the key benchmark ratio as a basis for amending assessments.40

2.65 For example, the benchmark webpage for delicatessens for the 2009-10 income year states that a delicatessen with an annual turnover between $65,000 and $250,000 has a benchmark range of 53 per cent to 67 per cent. That is, for a delicatessen that reports a cost of sales of $100,000, the ATO would expect a reported turnover of between $188,679 (53 per cent) and $149,253 (67 per cent).

2.66 The ATO also publishes the information performance benchmarks for that ATO benchmarked industry. These are listed in a table titled 'benchmark ratio' on the same webpage. Businesses can use these additional information performance benchmark ratios for their own information. The ATO does not use information performance benchmarks for risk identification or amended assessment purposes.

2.67 It should be recognised that the development of benchmarks is effectively invisible to the taxpayers ultimately affected. That is, the ATO is using information already provided in tax returns and activity statements to establish the benchmarks. The process of creating benchmarks has limited compliance costs for the taxpayer or their representatives beyond their normal reporting and lodging obligations.

Cash sales benchmark and its withdrawal

2.68 Between November 2010 and April 2011, the ATO published another type of benchmark that was different to the performance benchmarks described above. This benchmark was known as the cash sales benchmark and was developed by using third party data from banks in relation to card sales (i.e debit and credit cards) and sales figures from Business Activity Statements (BASs).

2.69 The cash sales benchmark was calculated using the following formula:

(Total sales reported on BAS minus total credit and debit card transactions reported by banks) divided by total sales reported on BAS.41

2.70 In contrast to the financial benchmarks which indicate business performance (such as profitability and margins), the cash sales benchmarks simply indicate what the ATO expects a business in a given industry to receive in cash as a proportion of their total sales.

2.71 The cash sales benchmark applied to the 2009 year. The benchmark covered the following 15 industries outlined in the table below:

Table 2: Industries covered by the cash sales benchmark
Beauty services Fuel retailing Meat retailing and butchers
Clothing retailing Garden supplies retailing Newsagents
Coffee shops Grocery retailing and general stores Pubs, taverns and bars
Florists Hairdressers Restaurants
Fruit and vegetable retailing Hardware and building supplies retailing Takeaway food services

Source: ATO Media Release 2010/37 9 November 2010.

2.72 The ATO intended to use the cash sales benchmark to indicate the proportion of business sales which could be attributed to cash or cards. Upon launching the cash sales benchmark, the ATO said:

Using these benchmarks, the ATO can determine the average proportion of cash sales a business should be making and which businesses are not reporting as much cash income as others in the same industry.42

2.73 However, on 1 April 2011, the ATO publicly announced the withdrawal of the cash sales benchmark. The reason for the ATO's withdrawal was outlined publicly as being:

A review of the data used to calculate the cash sales benchmarks has identified inconsistencies in the way in which cash-outs paid by businesses to their customers were recorded. (An example of cash-out is when a customer requests additional cash when purchasing goods or services.) Accordingly, the ATO believes it is appropriate to withdraw the cash sales benchmarks at this stage.43

2.74 At the time of withdrawal, the ATO had commenced around 1000 audits on the basis that they were outside the cash sales benchmark for two years44 (that is, it was used as a key benchmark ratio). Before the benchmark's withdrawal, nine audits resulted in adjustments based on the cash sales benchmark.45 These adjustments were later reversed.46

2.75 As a result of the benchmark's withdrawal, the ATO publicly advised that:

Our current audit work involving these benchmarks we [sic] be limited to a review of taxpayers' records and where appropriate we will provide taxpayers with advice on areas where these records can be improved. We will continue to monitor their performance against benchmarks in future years.47

2.76 The ATO has since advised the IGT that it will not be republishing the cash sales benchmark due to difficulty in obtaining consistent data on which to produce the benchmark and that it will formally publish such advice.48

How the ATO communicated the small business performance benchmarks

2.77 After the small business performance benchmarks were developed, they were 'launched' during October 2009 by:

  • publishing the benchmarks and explanatory information on the ATO's website;
  • referring to them in speeches by ATO executives and electronic communication to tax practitioners;
  • distributing flyers to small businesses during assistance visits from ATO staff; and
  • distributing fact sheets to industry associations.

2.78 After October 2009, additional communication of the performance benchmarks included:

  • articles in the ATO's The TAXAGENT magazine;
  • electronic communication to BAS service providers and state-based small business education networks; and
  • discussion in various ATO consultative forums.

2.79 The small business benchmarks remain on the ATO website. When launched in October 2009 and throughout 2010, the small business benchmarks related to the 2008 income year. In 2011, the ATO updated the benchmarks to reflect income tax returns and activity statements for the 2009 income year. In February 2012, the ATO further updated its website to reflect income tax returns and activity statements for the 2010 income year.

How the ATO uses the benchmarks for compliance activities

2.80 Once the benchmark ranges have been established, the ATO compares the ratios of businesses within the ATO benchmarked industries to see who is within them, and who is outside of the benchmarks. The ATO is only concerned with businesses that underreport income. So, by way of example, a delicatessen with cost of sales of $100,000, if it reported a turnover of $200,000, then its cost of sales/turnover ratio is 50 per cent, which is below the benchmark and does not represent an underreporting risk.

2.81 Out of the 900,000 businesses that were the subject of benchmarking, the ATO identified 76,000 that were 'significantly outside the benchmark' and, therefore, represented an underreporting risk.49

2.82 The ATO advises that it uses the performance benchmarks as a basis for case selection for a number of different types of compliance activities or 'products', that is bulk mail outs, record keeping assistance, phone reviews, record keeping audits and correspondence audits. The type of compliance activity a taxpayer is subjected to may depend upon the variation from the key performance benchmark. For cash economy audits, in addition to the benchmarks, the ATO uses the cash economy risk model as a basis for case selection.

2.83 The ATO has provided the table below (cash economy benchmark products) which provides an overview of the different compliance products the ATO uses. It should be noted that the table lists different types of 'outcomes' arising as a result of the compliance activity, including those that do not give rise to an adjustment of tax liability. However, the ATO's use of the term 'outcome' for the purposes of its reporting has a specific meaning — that is cases where a taxpayer's liability has been adjusted or a taxpayer has lodged an outstanding return as a result of the compliance activity. Each of these compliance products are described further below.

Table 3: Overview of benchmarking activities50
Products Form Purpose Outcome Focus Case source or general information
Bulk mail out Letter Help & educate; Encourage voluntary compliance No further action / voluntary disclosure Record keeping, help to comply Benchmarks / Industry specific
Record keeping assistance Field, voluntary Help & educate; Encourage voluntary compliance Help & educate Record keeping, help to comply New to business and low risk taxpayers from the risk model or slightly outside benchmarks
Phone review Desk Confirm entity & business description; Risk assessment No further action; Escalation; Voluntary disclosure; Identify correct entity Lodgment; Record keeping; Omitted income Outside benchmarks, risk model, and third party data population
Record keeping audit Desk and field Help and educate and Compliance No further action; Record keeping penalty with no, part, or full remission; Escalation Record keeping Outside benchmarks risk model population and cash economy analytical model population
Correspondence audit Desk Compliance No further action; Lodgment; Amendment; Default assessment; Imposition and consideration of false and misleading statement penalty; Escalation for prosecution Omitted income Outside benchmarks
Specific audit field Field Compliance No further action; Lodgment; Amendment; Default assessment; Imposition and consideration of false and misleading statement penalty; Escalation for prosecution Omitted income Internal and external referrals and escalations and third party data
Cash economy audit Field Compliance No further action; Lodgment; Amendment; Default assessment; Imposition and consideration of false and misleading statement penalty; Escalation for prosecution Omitted income Highest risk scored population from the risk model.

Bulk mail out letters program

2.84 During 2010, the ATO began compliance action based on the benchmarks for the first time. From May to December 2010, letters were sent to 37,847 taxpayers and to 20,967 of their tax agents (where the taxpayer indicated they had one) under a 'bulk mail out' letters program. The letters informed the taxpayer that they were outside the benchmarks and they ought to review their records to ensure all income (especially cash sales) had been disclosed.

2.85 The letter also indicated that:

If your business is selected for an audit or review, we may use the small business benchmarks to calculate your income tax or goods and services tax.51

2.86 If a business found an error in their records, then they were invited to disclose the error using an enclosed form. If the business was satisfied that their records were accurate and supported their tax returns, no further action was required.

2.87 The ATO focused on record keeping since 'a clear link exists between compliance with tax obligations and good record-keeping practices'.52

2.88 Of these letters, 938 taxpayers made voluntary disclosures about errors they found when they reviewed their own records. Taxpayers made self-adjustments to their own BAS or income tax return in 187 cases. A large proportion, however, (9796 or around 26 per cent of recipients) responded to the ATO with a letter stating that their records and returns were correct, and provided reasons for why their businesses were outside of the benchmark.

2.89 In 2011, similar letters were sent to 22,344 taxpayers and to 9,660 of their tax agents. The letters informed the taxpayer of tools and services available to assist them with their record keeping obligations. The ATO advises that the majority of these letters (16,107) were sent to taxpayers in the coffee shop and plastering industries, as part of a separate ATO focus, and the remainder were sent to taxpayers in other industries that were outside benchmarks. These letters did not invite taxpayers to respond and did not include a response form. The letter did, however, provide information to the taxpayer on how they could notify the ATO if they identified an error or omission. As a consequence of this, very few responses were received.

Table 4: Bulk mail out letters program 2010 and 2011
  Taxpayer letters sent Tax agent letters sent Responses Voluntary disclosure Self adjustment
2010 Letters 37,847 20,967 9,796 938 187
2011 Letters 22,344 9,660 15 0 0

Source: Based on ATO data provided to IGT on 23 December 2011 and 31 May 2012. This table is a compression and combination of separate tables provided by the ATO.

2.90 The ATO reports that during 1 July 2010 to 30 October 2011, around 300053 letter recipients made self-amendments to one or more of their BASs, while another 880 made voluntary disclosures of around $2.6 million.54

Record keeping assistance visits

2.91 The ATO has advised that its cash economy staff carry out record keeping assistance visits to 'new to business' and low risk taxpayers. The ATO initiates the visit by contacting the taxpayer by phone and explaining the purpose of the visit. The taxpayer is not obliged to accept the offer.

2.92 If accepted, the ATO officer will arrange a time and place as the visit is conducted at the taxpayer's premises. The visit focuses solely on the taxpayer's record keeping system and the officer does not examine the taxpayer records themselves unless requested by the taxpayer.55

Phone reviews

2.93 Phone reviews are at the lower end of intensity of the ATO's compliance products. They are not carried out for the purpose of a financial outcome. The purpose of ATO phone reviews is to contact taxpayers to:

  • confirm that the ATO business industry code and business description are correctly reported by the taxpayer;
  • identify where the income from identified activity has been reported; and
  • ensure business entities are aware of the need to meet their record keeping obligations and offer assistance in doing so.56

2.94 At the conclusion of the phone review, the ATO officer records the information in Siebel (the ATO's case management system) and ends the compliance activity. The ATO officer may include in Siebel a recommendation that the reviewed taxpayer undergo a 'correspondence audit'. The information is then collated by the Cash Economy Risk & Strategy committee which then assesses the information and makes a decision on whether to escalate the case to a correspondence audit. Correspondence audits are discussed below.

2.95 After feedback from taxpayers and tax practitioners, the phone review was modified and restarted in April 2011. As a result:

  • fewer questions are asked (now a maximum of 10 questions);
  • the review takes about 15 minutes to complete, compared to 30 — 40 minutes previously;
  • tax agents can complete the review on behalf of taxpayers (they were originally designed to be answered specifically by the taxpayer57); and
  • the questions were published on the ATO website.58

2.96 Commencing in January 2010, the ATO conducted a total of 9839 phone reviews up to April 2012. Since the phone review is designed to collect information and raise awareness of tax obligations, rather than directly detect underreported income, minimal outcomes are reported.

Table 5: Phone reviews
Phone reviews by financial year59 Nil outcome Outcome
July 2010 — June 2011 5508 5
July 2011 — April 2012 4321 5
Total 9829 10
Phone reviews between versions60 Nil outcome Outcome
July 2010 — April 2011(v1) 4771 3
April 2011 — April 2012(v2) 5058 7
Total 9829 10

Source: Table is compiled by the IGT from the ATO spread sheet data supplied on 23 December 2011 and 31 May 2012. These figures exclude early exit cases.

Version 1 and Version 2 phone reviews are separated by the date 18 April 2011, when the revised phone review was introduced.

Record keeping audits

2.97 The ATO uses a 'GST analytical model' and the 'Cash economy risk model' to assist in selecting taxpayers for a record keeping audit. This compliance activity has both an educational and compliance nature to it.61

2.98 ATO officers call selected taxpayers and ask about their record keeping systems. ATO officers then, with the aid of a record keeping questionnaire document, make evaluations on the adequacy of the business's record keeping systems and make recommendations to the business on improvements they need to make. ATO officers send the recommendations to taxpayers, along with the ATO guide Record keeping for small business.62

2.99 After giving taxpayers one month to make improvements, ATO officers then follow up the recommendations with a field visit to see if the improvements have been implemented. If they have not, ATO officers may issue taxpayers with a record keeping penalty of up to $2200. The detection of underreported income or the amendment of tax returns or business activity statements is not the main purpose of record keeping audits. The primary purpose is to improve record keeping standards in the community.63

2.100 Under the benchmarking strategy, the ATO conducted 927 record keeping audits starting in March 2010. It should be noted that where taxpayers have financial performance that falls outside the performance benchmarks by a certain range they will not be selected for a record keeping audit, but may instead be selected for a correspondence audit.64

Correspondence audits

2.101 Correspondence audits are a desk based activity where the ATO officer does not visit the taxpayer's premises during the course of the audit.

2.102 Before a taxpayer is contacted, an ATO officer will conduct some initial research to confirm the industry and business of the taxpayer and the applicability of the benchmark.

2.103 If the ATO determines that the wrong benchmark was applied, the audit may be closed before the taxpayer is contacted. Cases closed in this manner are known as 'early exit' cases.

2.104 Where the ATO officer is satisfied that the correct benchmark has been applied, the ATO officer will send an 'audit confirmation letter' to the taxpayer or their representative, notifying them of the commencement of the correspondence audit. See Appendix 6 for a sample of an audit confirmation letter. The audit confirmation letter requires the taxpayer to send sales records to the ATO for a sample quarter, usually April to June. The expected records include cash register reports, bank statements, daily sales summaries and reconciliations. Seven to ten days after the letter has been sent, the ATO auditor calls the taxpayer or their representative to discuss the audit and in particular:

  • the nature of the business of the taxpayer, to ensure the correct benchmark has been applied;
  • the reasons for variation from the benchmark;
  • what kind of records the taxpayer must submit and why the taxpayer is being audited; and
  • to ensure that the taxpayer is able to submit the records by the due date (initially 28 days from the letter being received) or to negotiate a new due date where appropriate.

2.105 Once the ATO receives the records, the auditor assesses their quality and completeness to determine whether the sales figures reported in the BAS and income tax returns are supported. In making that determination, ATO officers are guided by:

  • Taxation Ruling TR 96/7 Income tax: record keeping — section 262A — general principles;
  • the ATO publication Record keeping for small business guide;
  • the 'Record keeping questionnaire', an internal document; and
  • 'Record keeping audits — development guidelines', an internal training document.65

2.106 Where the records do not support the BAS or income tax return figures, the ATO auditor contacts the taxpayer to request further documentation to substantiate the sales figures. If the taxpayer does not provide any more records to substantiate the sales figures, the ATO officer issues an interim report to the taxpayer after it is approved by their team leader.

2.107 The interim report informs the taxpayer of the likely assessment if no further information is provided. The report usually applies the key benchmark to the taxpayer's reported cost of sales or total expenses to determine a new sales or business income figure and related amended assessment. It also outlines any applicable penalties.

2.108 For example, in the case of a delicatessen with a reported cost of sales of $100,000 and a reported turnover of $125,000, it would have a cost of sales/turnover ratio of 80 per cent. The 2010 benchmark range for the delicatessen is 53 per cent to 67 per cent. The ATO is, therefore, expecting the delicatessen to report a turnover between $149,253 (67 per cent) and $188,679 (53 per cent). Should the delicatessen not have satisfied earlier ATO enquiries and not have had adequate records to support their business income figure, the ATO would apply the top of the benchmark range to the taxpayer's reported cost of sales to derive a new business income figure of $149,253.

2.109 The interim report gives the taxpayer an opportunity (14 days) to refute the ATO's position and respond with any further records to substantiate the reported sales. Where the taxpayer does not respond, or their response is not satisfactory for the ATO, the audit is completed and the ATO officer sends the taxpayer an 'audit finalisation letter'. If the ATO's position has not changed since the interim report, the finalisation letter confirms that it will be making adjustments according to the interim report.

2.110 The taxpayer may respond to the interim report with evidence advocating a different method of adjusting the income tax returns and BASs. If accepted, the finalisation letter may indicate acceptance of that method. The income tax returns and business activity statements are then adjusted in accordance with the finalisation letter. In either case, this is what the ATO calls a 'default assessment'.

2.111 If at any point, the auditor decides (in consultation with their team leader) that the records adequately evidence the taxpayer's BAS and income tax return figures, the audit can be finalised with no further action.66 Furthermore, where the records are adequate, but the auditor identifies deficiencies or weaknesses in the taxpayer's record keeping, the finalisation letter to the taxpayer will also make recommendations to improve their record keeping.

2.112 Beginning in May 2010, the ATO began these correspondence audits on taxpayers whose financial performance was significantly outside the benchmarks. The first round of correspondence audits concerned the 2008 income year and relied on the 2008 small business benchmarks.

2.113 These taxpayers were outside the benchmarks to the extent that they were considered a higher risk, such that an advisory letter and phone review (discussed above) alone was considered not enough to address the risk. In this sense, the ATO has effectively placed these taxpayers higher up the ATO compliance model than those taxpayers who only received a letter or a phone call, but lower down the model than those who undergo a 'cash economy audit'.

2.114 The following table shows that overall, just under one quarter of correspondence audits resulted in an outcome.

Table 6: Completed correspondence audits July 2010 to April 2012
Year Nil outcomes Outcomes Total Outcomes as a percentage
of total cases(a)
July 2010 — June 2011 3622 1104 4726 23.4%
July 2011 — April 2012 2169 775 2944 26.3%
Total 5791 1879 7670 24.5%

Source: Figures compiled by IGT from ATO spread sheet data supplied to IGT 23 December 2011 and 31 May 2012.

Note (a): Total cases = Nil outcomes + Outcomes.

Specific audits

2.115 The ATO also has advised that it conducted 'Specific audits' under the benchmarking strategy. There are two types of specific audits, only one of which is conducted within the benchmarking program. The first type is aimed at 'testing reporting of specific third party data transactions'67 and is a field based activity. These audits would either result in no further action, an amended assessment or an escalation to a cash economy audit. These cases are non-benchmark related.

2.116 The second type of specific audit is 'to make amendments to the directors or partners' individual income tax returns as a result of compliance action relating to company or partnership returns.'68 These cases are flow-on adjustments from benchmarking cases. These would usually result in an amended assessment. The ATO conducted 143 such specific audits under the benchmarking strategy since January 2010.

Cash economy audits

2.117 The ATO also conducts cash economy audits under the benchmarking strategy. Taxpayers would only be subject to a cash economy audit under the benchmarking strategy if they also met the requirements under the cash economy risk model, or during another compliance activity (for example a correspondence audit), where evidence emerged to justify an escalation to a cash economy audit. The ATO has conducted 276 cash economy audits under the benchmarking strategy since March 2010.

Summary of benchmarking activities

2.118 The following table illustrates the number of compliance activities associated with benchmarking from January 2010 to April 2012. As discussed above, cases which are recorded as an 'early exit' are where the compliance activity was created on ATO systems but closed before taxpayer contact was made.

Table 7: Summary of benchmarking strategy activities from January 2010 to April 2012
Intensity
and type
Product Early exit Nil Outcome Outcome Total initiated cases(a) Early exit rate(b) Total completed cases(c) Strike rate(d) Planned strike rate(e) Objections Objection rate(f) Liabilities raised(g)
Highest (field, compliance) Cash Economy Audit 65 133 143 341 19% 276 52% 60% 17 12% $5,856,166
(field, compliance) Specific Audit 7 41 102 150 4% 143 71% 70% 14 14% $2,552,445
(desk, compliance) Correspondence Audit 457 5791 1879 8127 6% 7670 24% 32% 235 13% $57,097,719
(field+desk, compliance) Record keeping audit 526 823 104 1453 36% 927 11% 40% 3 3% $652,301
(desk, compliance) Phone review 374 9829(h) 10 10213 4% 9839 <1% 0% 0 0 $117,358
Total compliance(i)   1430 16448 2420 20298   18868     269   $66,488,591
(letter, advisory) Bulk mail out letters program 2010 n/a n/a n/a 37847(j) n/a n/a n/a n/a n/a n/a n/a
Lowest (letter, advisory) Bulk mail out letters program 2011 n/a n/a n/a 22344(j) n/a n/a n/a n/a n/a n/a n/a

Source: Figures compiled by IGT from ATO spread sheet data supplied 23 December 2011 and 31 May 2012.

Note (a): Total initiated cases = Early exit + Nil outcome + Outcome

Note (b): Early exit rate = Early exit / Total initiated cases

Note (c): Total completed cases = Nil outcome + Outcome

Note (d): Strike rate = Outcome / Total completed cases

Note (e): Source: 2011-12 Cash Economy Staff Allocation and Case Numbers, supplied by ATO, 23 February 2012.

Note (f): Objection rate = Objections / Outcome

Note (g): Liabilities raised = GST + 'other heads of revenue' including income tax. Liabilities in this column excludes penalties.

Note (h): ATO data initially indicated 9658 nil outcome cases and 181 outcome cases. However only 10 outcome cases had liabilities or lodgments recorded against them. The IGT has classified the remaining 171 cases nil outcome cases and added them to the nil outcome figure.

Note (i): Totals may be affected by the phone review product, which may not give a representative indication of the rest of the compliance products

Note (j): Figure excludes letters also sent to the taxpayers' representatives

2.119 It is apparent from the above table that, of the products designed to identify omitted income, the most frequently used product was the correspondence audit. By contrast, cash economy audits are the most intensive product but were low in number compared to correspondence audits. In terms of coverage, the bulk mail out letters program reached the most number of taxpayers.

2.120 The majority of submissions from stakeholders related to correspondence audits. We also received significant feedback on the phone reviews and the bulk mail out letters program. Whilst correspondence audits attracted the highest number of objections, they accounted for 13 per cent of outcome cases compared to a 12 per cent objection rate for cash economy audits.

2.121 The timeline below indicates when various benchmarking activities commenced.

Figure 6: Timeline of benchmarking activities

Graphic giving a timeline of benchmarking activities.

2.122 The timeline indicates that the bulk mail out letters program commenced at the same time that correspondence audits were initiated, and six months after the ATO launched the benchmarks. It should be noted that a second bulk mail out letters program was issued in October and November 2011.

2.123 The Cash Economy Plan 2011-12 shows how many full time equivalent (FTE) staff were allocated to the various compliance activities, how many cases were planned and how much revenue was expected. The plan originally broke up the products into their respective heads of funding (that is business as usual, 2009 Federal Budget Funding and 2010 Federal Budget Funding). For convenience, however, they are combined in the table below:

Table 8: Cash Economy Plan 2011-12
Product FTE Planned Cases Planned Revenue(a) Average FTE per $10m in planned revenue(b) Planned Average revenue per case(c) Actual average revenue per completed case(d)
Cash economy audits 172.89 670 $28.9m 59.82 $43,134 $25,832
Specific audits 19.71 360 $5.5m 35.84 $15,277 $10,546
Correspondence Audits 139.19 4567 $61.4m 22.67 $13,444 $8210
Record keeping audits 41.24 2260 $0 n/a $0 $171
Phone reviews 9.3 8858 $6m 15.5 $667 $15

Source: Table compiled by IGT from data provided by ATO 23 February 2012.

Note (a): GST and Income tax excluding penalties in millions of dollars rounded up to the nearest $100,000.

Note (b): These figures were calculated by the IGT as (FTE / Planned Revenue) x 10.

Note (c): These figures were calculated by the IGT. This is assumed to be the average per 'completed case', being those that include outcomes and nil outcomes.

Note (d): These averages were derived by the IGT from Table 7 above being Liabilities raised / Total completed cases.

2.124 It should be noted that the above activities are in relation to all of Cash Economy's activities, not just the benchmarking strategy. The ATO has advised the IGT, however, that the vast majority of correspondence audits and phone reviews were part of the benchmarking strategy. Conversely, record keeping audits, specific audits, and cash economy audits can all be initiated via other means and not just the benchmarking strategy.

2.125 The column 'average revenue per case' highlights that correspondence audits were not intended to raise as much revenue per case compared to cash economy audits. Cash economy audits are undertaken where the risk identified is greater, using the cash economy risk model.

2.126 It is also important to note, however, that the average cost of conducting a correspondence audit (in terms of FTE audit staff) is much lower than that for cash economy audits. So whilst correspondence audits are anticipated to yield less revenue per case, the ATO may conduct many more of these audits.

2.127 When compared to the results of actual cases conducted between January 2010 and November 2011, it can be seen that the average liabilities raised per completed case is lower than planned. This is particularly so for the 'higher risk' cash economy audits, and the 'higher volume' correspondence audits.

Record keeping

2.128 As discussed above, the focus of the ATO's benchmarking compliance activities is to ensure businesses report all their income and to verify that the businesses have sufficient records to evidence this income. Where the ATO considers that a business does not have adequate evidence (including those records that would meet the ATO's record keeping requirements), the ATO may decide to issue a default assessment. Thus, one of the key issues in determining whether income has been omitted is whether there is adequate evidence to substantiate the business's income. Keeping appropriate records provides one of the strongest forms of evidence.

2.129 Under self-assessment, taxpayers are not required to send documentation to the ATO to substantiate the figures they report in their BAS and income tax returns. Nevertheless, section 262A of the Income Tax Assessment Act 1936 (ITAA 1936) requires a person carrying on a business to, amongst other things:

(1) [to] keep records that record and explain all transactions and other acts engaged in by the person that are relevant for any purpose of this Act.

(3)(b) [to] keep the records so as to enable the person's liability ... to be readily ascertained ...

(4)(a) [to] retain those records until . the end of 5 years after those records were prepared or obtained, or the completion of the transactions or acts to which those records relate, whichever is the later.

2.130 The retention of taxpayer records allows the ATO to undertake verification activities after lodgment to ensure that the figures that taxpayers report in their returns are correct.

2.131 The ATO issued Taxation Ruling TR 96/7 Income tax: record keeping — section 262A — general principles. This ruling sets out the kinds of records the ATO expects various types of businesses to keep.

2.132 Additionally, the ATO publishes educational materials to assist businesses with record keeping. This is due to the ATO identification of micro business record keeping as a systemic risk.69 It therefore focuses its education activities on record keeping to help taxpayers to record and report all of their income and expenses so that it can be easily verified.

2.133 Whilst record keeping is the responsibility of the business owner (especially since most records are created when business transactions are performed by the business owner), several other stakeholders may be involved in the record keeping of the business. For example, some micro businesses may regularly engage a professional bookkeeper to ensure their records are correct and up to date (43 per cent according to ATO research70). Many businesses also engage an accountant (79 per cent) for a number of reasons, including record keeping. Importantly, 93 per cent of all micro business tax returns are lodged by registered tax agents and 50 per cent use BAS agents to lodge activity statements.

2.134 It should be noted that the ATO's ability to initially verify the correctness a taxpayer's records is limited to the information to which the ATO has access. Whilst the ATO has direct access to a broad range of data sourced from taxpayer returns and many external third party sources, the ATO may need to request a broad range of records and responses directly from taxpayers.


2 Or 'hidden economy', 'informal economy'. OECD Forum on Tax Administration SME Compliance sub-group Information note: Reducing opportunities for tax non-compliance in the underground economy, January 2012, para. 2

3 Australian Taxation Office, Enterprise Risk Management Framework, extract supplied by ATO, 29 May 2012.

4 Australian Taxation Office, About the cash economy, Australian Taxation Office, Canberra, 19 August 2011, viewed 21 June 2012.

5 Australian Taxation Office, Communication Strategy Small Business Benchmarks, 22 September 2009, page 10, supplied by ATO 23 January 2012.

6 Australian Taxation Office, Compliance Program 2011-12, page 45.

7 Australian Taxation Office, Compliance Program 2009-10, page 16.

8 ATO communication to IGT, 31 May 2012.

9 Australian Taxation Office, Coffee suppliers data matching, Australian Taxation Office, Canberra, 22 June 2012, viewed 2 July 2012.

10 ibid.

11 Australian Taxation Office, Small business benchmarks - Overview, Australian Taxation Office, Canberra, 22 May 2012, viewed 2 July 2012.

12 Australian Taxation Office, Cash Economy Plan 2011-12, supplied by ATO 23 February 2012.

13 Australian Taxation Office, Small business benchmarks, Australian Taxation Office, Canberra, viewed 2 July 2012.

14 Australian Taxation Office, ATO Small business benchmarks: Promoting a level playing field for Australian small business, November 2011, supplied by ATO 24 November 2011.

15 Australian Taxation Office, Promoting a level playing field for Australian small business: funding bid, March 2009, supplied by ATO 22 March 2012.

16 Australian Taxation Office, Tax Practitioner and Lodgment Strategy (TPALS) Cash Economy Measuring Compliance Effectiveness: Small Business Benchmarks 2010-11, supplied by ATO 23 February 2012.

17 Australian Taxation Office, Small business benchmarks - Overview, Australian Taxation Office, Canberra, 22 May 2012, viewed 2 July 2012.

18 Australian Taxation Office, Compliance Program 2011-12, pp. 11 and 15.

19 Organisation for Economic Cooperation and Development (OECD) Forum on Tax Administration: SME Compliance sub-group, Information Note: Reducing opportunities for tax non-compliance in the underground economy, January 2012, viewed 23 March 2012.

20 ibid, para 4.

21 GfK bluemoon, Profiling the micro business segment communication and information needs, Final Report prepared for the Australian Taxation Office November 2008, viewed 20 February 2012.

22 Australian Taxation Office, Compliance Program 2011-12, page 11.

23 B. Quigley, speech to TIA National Convention Sydney 12 March 2009, The Commissioner's powers of general administration: how far can he go?, viewed 20 February 2012.

24 Australian Taxation Office, Compliance Program 2008-09, page 8.

25 Australian Taxation Office, Record keeping evaluation tool, Australian Taxation Office, Canberra, 28 June 2012, viewed 2 July 2012.

26 Australian Taxation Office, E-Record Withdrawal, Australian Taxation Office, Canberra, 5 October 2010, viewed 20 February 2012.

27 Description of Cash Economy compliance products supplied by ATO 18 January 2012.

28 Australian Taxation Office, Speakers and seminars, Australian Taxation Office, Canberra, viewed 13 July 2012.

29 ibid.

30 ATO communication to IGT received 8 February 2012.

31 Description of Cash Economy compliance products supplied by ATO 18 January 2012.

32 Australian Taxation Office, ATO Business industry codes, Australian Taxation Office, Canberra, 30 May 2012, viewed 2 July 2012, NAT 1827-6.2012.

33 ATO communication to IGT 31 January 2012.

34 ATO communication to IGT 30 January 2012.

35 ATO communication to IGT 31 January 2012. - The Mahalanobis Distance technique is a statistical tool used to help determine whether particular data points (in this case, the ratios) properly belong to a particular set (in this case, an industry). Whilst the industry allocation technique uses the ATO business industry codes and keyword searches help to identify who belongs to an industry, the ATO's use of the Mahalanobis Distance adds an extra layer to the process to exclude those who may have selected the wrong industry, or who may have entered incorrect information in the income tax return labels.

36 ATO communication to IGT 31 January 2012.

37 ATO communication to IGT 31 January 2012.

38 Australian Taxation Office, Small business benchmarks, Australian Taxation Office, Canberra, viewed 2 July 2012.

39 Australian Taxation Office, Small business benchmarks - Overview, Australian Taxation Office, Canberra, 22 May 2012, viewed 2 July 2012.

40 Australian Taxation Office, Small business benchmarks: how we use the benchmarks, Australian Taxation Office, Canberra, 22 May 2012, viewed 2 July 2012.

41 Australian Taxation Office, Briefing - Cash sales benchmark error (dated 29/03/2011), supplied by ATO 23 February 2012.

42 Australian Taxation Office, New ATO benchmarks focus on cash sales Media Release 2010/37, Australian Taxation Office, Canberra, 9 November 2010.

43 Australian Taxation Office, Cash sales benchmark withdrawn 1 April 2011 - Tax agent and BAS agent broadcast, Australian Taxation Office, Canberra, 1 April 2011.

44 Australian Taxation Office, Briefing - Cash sales benchmark error (dated 29/03/2011), supplied by ATO 23 February 2012.

45 Australian Taxation Office, Update on status of Cash Sales Benchmark Casework internal report dated 22 March 2012, supplied by ATO 22 March 2012.

46 ibid.

47 Australian Taxation Office, Cash sales benchmark withdrawn 1 April 2011 - Tax agent and BAS agent broadcast, Australian Taxation Office, Canberra, 1 April 2011.

48 ATO communication to IGT, 7 June 2012.

49 Australian Taxation Office, ATO Small business benchmarks: Promoting a level playing field for Australian small business, November 2011, supplied by ATO 24 November 2011.

50 ATO table supplied to IGT, 29 May 2012.

51 Sample of ATO bulk mail out letter, sent to taxpayers on 20 September 2010. Supplied by ATO 23 December 2011.

52 Australian Taxation Office, Compliance Program 2011-12, page 12.

53 These amendments were made regardless of whether the taxpayer formally notified the ATO of their intention to do so. Those that did notify the ATO are reflected in table 4.

54 Australian Taxation Office, ATO Small business benchmarks: Promoting a level playing field for Australian small business, November 2011, supplied by ATO, 24 November 2011.

55 ATO communication to IGT, 31 May 2012.

56 Description of Cash Economy compliance products supplied by ATO, 18 January 2012.

57 ATO communication to IGT, 23 December 2011.

58 Australian Taxation Office, Cash economy frequently asked questions: Cash economy phone review, Australian Taxation Office, Canberra, 21 February 2012, viewed 23 February 2012.

59 July 2010 - June 2011 contained 31 cases listed as having an outcome, but only 5 of these cases reported revenue or lodgment against them. The remaining 26 cases have been added to the 5482 nil outcome cases. July 2011 - April 2012 contained 150 cases listed as having an outcome, but only 5 of these cases reported revenue or lodgment against them. The remaining 145 cases have been added to the 4176 nil outcome cases.

60 July 2010 - April 2012 contained 20 cases listed as having an outcome, but only 3 of these cases reported revenue or lodgment against them. The remaining 17 cases have been added to the 4754 nil outcome cases. April 2011 - April 2012 contained 161 cases listed as having an outcome, but only 7 of these cases reported revenue or lodgment against them. The remaining 154 cases have been added to the 4904 nil outcome cases.

61 ATO Record Keeping Audit Product Committee Minutes February 2011, supplied by ATO, 2 March 2012.

62 Australian Taxation Office, Record keeping for small business (NAT 3029), Australian Taxation Office, Canberra, May 2011.

63 Australian Taxation Office, Penalties for not keeping records: what is our approach to record keeping and penalties?, Australian Taxation Office, Canberra, 25 August 2010, viewed 2 July 2012.

64 ATO case selection methodology supplied 23 February 2012.

65 ATO communication to IGT, 23 January 2012.

66 Australian Taxation Office, Taxpayers who are outside benchmarks - end to end process, supplied by ATO, 24 November 2011.

67 Description of Cash Economy compliance products supplied by, ATO 18 January 2012.

68 Description of Cash Economy compliance products supplied by ATO, 18 January 2012.

69 ATO Strategic Risk Register: Compliance; Risk SR2/2 - Issued August 2011.

70 GfK bluemoon, Profiling the micro business segment communication and information needs, Final Report prepared for the Australian Taxation Office November 2008, viewed 20 February 2012.