Common tax return red flags that can trigger an ATO audit

It is a scenario most people hope they will never face: being red flagged for an audit after submitting a tax return to the Australian Tax Office (ATO). 

But even if you think it will never happen to you, the reality is that it can. Each year, the ATO reviews or audits a considerable number of individuals, family groups and businesses. 

Being singled out can feel confronting, especially if you’re unsure what triggered the audit or review to begin with. To help you stay in the green, here’s what you need to know about ATO audits and the types of activities that may raise red flags in your tax return.

How ATO audits typically work

When something in your tax return doesn’t sit quite right, the ATO will rarely launch a full blown audit. Instead, they’ll state that they wish to conduct a review and issue a request for information (RFI). 

This RFI will explain the time period that the ATO is concerned about – such as the past two financial years for an individual, or the past eight quarters for a business. They may be focussed on areas like:

• deductions
• undeclared income
• GST claims
• PAYG withholding
• superannuation payments

To support the review, the ATO will request all documentation related to that period. This includes all paperwork supporting any claims you made. 

Even though this is not a full ATO audit, it can be stressful and time consuming. Often you will have 2-4 weeks to produce what the RFI asks for, and if you don’t have an accountant it can be especially painstaking. 

Responding to an RFI from the tax office

If you do have an accountant, they will likely have most of the information needed to respond to the ATO’s request and liaise with them on your behalf. If they don’t have it, or you’re trying to pull the information together yourself, you will need to act quickly or request a time extension.

The ATO is usually lenient in allowing more time, especially if you’re upfront with them. The same applies if, while compiling the documentation, you become aware of any errors – such as claiming something you cannot substantiate. When you’re honest about such an error and make a voluntary disclosure, you’re more likely to avoid serious penalties.  

Once you submit your information, the ATO may take several weeks (or even a couple of months) to review and advise next steps. This may include:

1. Requesting more information.
2. Launching an investigation or audit.
3. Advising nothing further is required. 

While this is the typical course of action, the ATO can choose to start with a full audit. It just depends on the circumstances and how many red flags you or your business have raised. 

Common red flags that trigger an ATO audit

How the ATO chooses who to review or audit depends on a number of factors. 

For example, large taxpayers are subject to regular reviews. This includes the Top 100 public companies, Top 500 privately held groups, and the ‘Next 5,000’ (the next 5,000 taxpayers after the top 500). 

For everyone else, it generally comes down to anomalies in tax returns or business activity statements. Let’s take a look at what the ATO may consider an anomaly…

1. Inconsistencies with other reported information

The ATO’s data matching capabilities have evolved significantly over the past decade. They now match data with:

• financial institutions
• other government agencies
• AUSTRAC (financial intelligence agency)
• private companies

For example, Airbnb and Uber must report information about hosts and drivers so the ATO can identify any income from these sources. The ATO also matches data on government payments, and even income received from overseas. If you fail to report these and the numbers don’t add up, it will increase your risk of a review or audit.

The same applies to cryptocurrency, as crypto exchanges now required to report on their customers. 

2. Benchmarking tax returns

Over the years, the ATO has collected extensive data on tax returns across different industries and professions. For example, the ATO has benchmarks for typical income and claims across professions, from nurses and carpenters to doctors, accountants, and public servants. 

Claiming in excess of the usual deductions could raise a red flag. So if you do have unusual expenses as part of your role, it’s essential to keep real time records to substantiate them. 

Unusually high income or spending compared with your declared income is also likely to trigger red flags. The ATO might learn about this through data matching, or even third party avenues such as social media.  

3. Inconsistencies in returns

Businesses that submit inconsistent business activity statements are a common red flag. This could include large deductions or payments to contractors – which in turn can trigger questions about whether a contractor is actually an employee. 

In construction, we might see an ATO review stem from a large GST claim after purchasing a property. Provided all the paperwork is in order, these types of reviews are easy to complete and the business can quickly carry on as usual. 

4. Your business deals in cash

The ATO closely monitors cash-heavy businesses such as retail, hospitality, and trades.

Because unreported cash is a high risk to them, it puts the onus on you as the owner to maintain strong record keeping and accurate reporting to avoid being audited. 

5. You operate through a trust

The ATO has recently intensified its focus on trusts, with the potential for retrospective action against non-compliance with trust-related tax laws. 

This usually revolves around who receives distributions and whether or not they are allowable under tax law. For example, income splitting has been called out as a potential form of tax evasion likely to attract ATO scrutiny. 

6. You have a self-managed superfund (SMSF)

SMSF’s are subject to ATO reviews for a variety of reasons, such as:

• non-arm’s length income or expenses
• early or inappropriate withdrawals
• failure to diversify assets

Being aware of these common triggers and keeping your SMSF compliant can help reduce the risk of attracting an audit. 

Reducing the likelihood of an ATO review or audit

Fear of an audit shouldn’t stop you from claiming what you’re legitimately entitled to. The key is to know your rights and obligations, and to maintain good records in case you are selected for a review. 

Given the time and expense often associated with undergoing a review or audit, audit insurance can be a helpful safeguard. It covers some or all of the cost of engaging your accountant to facilitate the process – providing extra peace of mind in an otherwise difficult situation. 

If you believe you would benefit from audit insurance, contact your local RSM tax team.  

Keep in mind too that not all income is required to be reported. Knowing the difference between reportable and exempt income is another way to gain peace of mind when completing your tax return. 

Tax law can be complex, which is why it’s always a good idea to form a strong relationship with a trusted accountant. Keep them up to date on your affairs, and allow them to guide you in achieving maximum tax efficiency while maintaining compliance. 

A trusted accountant is also an important lifeline during a review or audit – working closely with you throughout the process and liaising with the ATO so you don’t have to. 

If you’re in need of a trusted business adviser or accountant, we can help. RSM’s multifaceted team has a wealth of experience helping individuals and businesses manage risk and maintain compliance so they can confidently manage, preserve, and build their financial assets.
 

For more information

To learn more about ATO reviews and audits, including risk mitigation or compiling a review or audit response, contact your local RSM office.