ATO taking a more aggressive approach to risk reviews for Next 5,000

The Australian Taxation Office’s (ATO) Next 5,000 program is traditionally an assurance program for privately-owned groups with controlled wealth of >$50m that sit outside the Top 500 private groups tax performance program. ^[1]

ATO engagement based on assurance in the context of the Next 5,000 program has to date been conducted through Streamlined assurance reviews (SAR) following the ATO’s adopted Justified Trust methodology, however, we are aware that there has been a recent change in ATO approach to revert taxpayer engagements to comprehensive risk reviews (CRR) in certain circumstances, including where:

• The ATO has found in a previous SAR that the taxpayer had insufficient documented governance controls; or
• ATO’s data analysis and risk profiling has identified:
  • Key emerging risks affecting some private groups, and tax issues relating to the Next 5,000 key priority areas ^[2]

SAR v CRR

The scope of a SAR is generally limited to:

• reviewing the tax returns lodged for the last 2 years
• the entities in the group with significant activities, events and transactions
• completion over a 4-month period from when the ATO receives the taxpayer responses to the first request for information (RFI 1).

With SARs, the onus is placed on taxpayers to provide “assurance” to the ATO that they are paying the right amount of tax based on the 4 pillars (or focus areas) of justified trust:

1. Appropriate tax risk management and governance frameworks exist and are applied in practice.
2. None of the specific tax risks flagged to the market are present in the business.
3. Tax outcomes for atypical, new or significant transactions are appropriate.
4. Understanding and explaining why the accounting and tax results vary.

In contrast, the scope of a CRR can be somewhat larger, i.e.:

• a CRR would generally encompass all entities within the group, have a substantially broader scope by including more tax return years, and hence last for a longer period (potentially more than a year depending on scope and complexity).

A CRR will include a one-month notification period where the ATO invite your client to provide readily available documents.

The ATO has observed that some Next 5,000 groups are making errors in their tax returns that could be otherwise prevented. These errors are due to a lack of documented governance processes, procedures and poor record keeping.

• Common tax issues where the ATO is not able to obtain assurance (and hence, more chance of ending up in CRR territory) include:
• Lodging disclosure errors, late lodgment, no lodgment of accompanying schedules to the income tax return.
• Cross-border transactions with related parties, e.g. questionable expense and revenue recognition where the service provided is not documented in a management service agreement, omitted or understated income, incomplete records.
• Entering into intra-group arrangements resulting in an inappropriate transfer of wealth, e.g., not taking enough steps to satisfy Div 7A including loans made through interposed entities, no written loan agreements or minimum yearly repayments etc.
• Concerns over beneficiary entitlement to trust distributions
• Capital gains tax errors on sale of significant assets, e.g. typing and arithmetic errors in the capital gains tax calculation.
• Business as usual expenditure where a nexus between the expense and assessable income could not be evidenced. A high proportion of these expenses are related party transactions.
• Goods and services tax (GST) - from the GST integrated SARs undertaken to date - ATO observations:

Errors and omissions in BAS disclosure labels, typically relate to:

• export sales
• input taxed supplies
• related party recharges
• GST-free items more broadly

There is a strong correlation between the BAS disclosure errors and a lack of governance processes and procedures.

As at 31 August 2023, the ATO has finalised around 1,078 SARs and commenced new engagements with a significant number of Next 5,000 groups under the program.

These engagements are a combination of SARs and risk-based reviews including CRRs.

ATO’s key observations from their reviews to date

• A high proportion of Next 5,000 program participants have governance processes and procedures, but most are not documented
• Clearly documented roles and responsibilities lead to good tax governance
• Documentation of the tax return preparation, review process and identification of material transactions helps groups to recognise tax risks and issues and avoid errors.
• Private groups that seek tax advice for material risks and issues are more likely to make correct disclosures and adopt correct tax treatments.

Key message to takeaway

The ATO’s change in approach to also engage Next 5,000 participants via CRRs signifies that once assurance cannot be obtained by the ATO, the taxpayer’s affairs will likely be more extensively scrutinised through its risk review approach adopted in CRRs which are generally more rigorous, onerous, stressful and time consuming for taxpayers. It follows that being able to demonstrate effective tax governance plays a key role in helping our clients maintain their assurance “status” in upholding justified trust in their less exhaustive SAR’s. This allows them to dedicate more time to the normal day-to-day running of their business as opposed to having to commit what could be lengthy amounts of side-tracked time to responding to ATO risk reviews and even audits in worse-case scenarios. In addition, clients much prefer to hear the word “assurance” rather than “risk” in their ATO reviews.

FOR MORE INFORMATION

If you would like to learn more about the topics discussed in this article, please contact your local RSM office.

[1]The Top 500 private groups tax performance program include private groups: (1) with over $250 million turnover, regardless of net asset value, (2) with over $500 million of net assets, regardless of turnover, (3) with over $100 million turnover and $250 million in net assets, or (4) that are market leaders or groups of specific interest.

[2] Next 5,000 Key priority areas include:

• Groups that are experiencing rapid growth and their tax governance framework is not fit for purpose  
• Cross-border transactions with related parties  
• Domestic wealth transfer involving intra-group transactions resulting in an ‘inappropriate’ transfer of wealth  
• Wealth extraction by use of private equity funds  
• Restructuring of the group for the purpose of intergenerational transfer of wealth (I.e. purpose of new structure is for succession planning rather than business-oriented)